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University  of  Illinois  Urbana-Champaign  Alternates 


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An  outline  of  the  history  of  the 
railroads  up  to  the  present  time, 
and  of  facts  to  be  considered  in 
purchasing  railroad  investments 


Copyrighted  1921 
Federal  Securities  Corporation 
Chicago 


3’r5.  '73 

■F3lr 


Federal  Securities  Corporation 


IMTEODUCTION 

Throughout  the  country  there  is  manifest  a widespread 
interest  in  the  railroad  situation  and  in  railroad  invest- 
^ ments.  It  is  no  new  interest  for  the  railroads  have  always 
occupied  an  important  place  in  the  activities  of  the  country, 
^ but  more  recently  this  interest  seems  to  have  grown  wider. 

This  is  probably  due  to  two  factors — first,  to  the  constantly 
o changing  aspect  of  the  railroad  situation  during  the  past 
^ four  or  five  years  and  the  changing  aspect  of  the  problem 
^ which  it  has  been  necessary  for  the  railroads  to  face ; 

CM 

second,  to  the  various  railroad  ofiferings  involving  large 
amounts  of  money  at  high  rates  of  interest,  which  have 
been  so  readily  absorbed  by  the  investing  public. 


During  1921,  the  railroads  of  the  United  States  needed 
approximately  $456,000,000  to  take  care  of  maturing  obliga- 
tions. It  has  been  estimated  by  Mr.  John  J.  Esch,  who  is 
one  of  the  joint  authors  of  the  Transportation  Act,  passed 
by  Congress  early  in  1920,  that  the  railroad  companies  will, 
in  addition,  need  about  $1,500,000,000  of  new  money  each 
year  for  a period  of  from  three  to  five  years.  This  amount 
of  financing  will  bring  before  the  public  a great  many  issues 
of  bonds  of  varying  degrees  of  worth.  The  situation  is  and 
has  been  so  complicated  and  the  individual  investor  so 
unlikely  to  have  the  opportunity  to  investigate  its  ramifica- 
tions  fully,  that  this  little  booklet  is  offered  in  the  hope 
. that  it  will  help  the  investor  choose  his  investments  with 
'^wisdom. 

^ Such  a booklet  should,  in  our  opinion,  (1)  deal  briefly 
with  the  past  history  of  the  railroads  up  to  the  outbreak  of 
the  European  War;  (2)  give  in  more  detail  the  situation 


5 


Hailroads  From  the  Investor’s  Viewpoint 


since  that  time  up  to  the  present ; and  (3)  outline  to  in- 
vestors the  factors  which  should  be  considered  in  choosing 
railroad  investments.  In  this  booklet,  we  shall  endeavor  to 
deal  briefly  with  all  three. 


Federal  Securities  Corpokatioi^ 


I 


FEOM  CIVIL  WAR  TO  WORLD  WAR 


The  very  early  history  of  the  railroads  of  this  country 
can  be  passed  over  very  briefly,  because  the  more  recent 
history  is  more  important  for  our  purpose.  The  story  of 
the  railroads  of  this  country  is  almost  kaleidoscopic  in 
retrospect  and,  therefore,  highly  interesting.  In  the  early 
days,  before  the  carriers  were  placed  under  the  jurisdiction 
and  control  of  the  Interstate  Commerce  Commission,  the 
situation  gave  a free  reign  to  shrewd  and  clever  operators 
to  use  the  railroads  for  their  own  ends,  either  for  the  pur- 
pose of  manipulation  to  make  profits  in  the  stock  market 
in  the  manner  of  Jay  Cook  and  Jay  Gould,  or  to  build  up  a 
tremendously  powerful  structure,  such  as  E.  H.  Harriman 
built  up  with  the  Union  Pacific  as  a nucleus. 

We  have  said  that  the  story  of  the  roads  is  one  of 
constantly  changing  situations.  Roads  like  the  New 
Haven,  the  stock  of  which  for  many  years  was  considered 
one  of  the  sound  investments  in  the  country,  in  the  space 
of  a very  few  years  under  the  control  of  Mr.  Mellen,  was 
brought  to  such  a pitiable  plight  that  the  United  States 
authorities  were  forced  to  intervene  in  an  attempt  to  correct 
the  situation.  This  road,  formerly  prosperous,  is  today 
going  along  at  a starvation  rate,  and  it  would  seem  as 
though  the  prospect  of  dividends  for  the  stockholders  is 
exceedingly  remote.  The  Boston  and  Maine,  another  of 
the  New  England  roads,  paid  dividends  on  its  stock  unin- 
terruptedly for  a period  of  practically  seventy  years  until, 
in  1914,  the  same  influences  which  wrecked  the  New  Haven 
involved  it  also  to  such  an  extent  that  its  dividends  were 
passed.  The  Maine  Central,  another  prosperous  New  Eng- 
land road,  which  had  paid  dividends  practically  as  long  as 
the  Boston  and  Maine,  in  the  early  part  of  1921  also  passed 
its  dividend.  These  instances  show  change  from  prosperity 
to  starvation  which  is  also  duplicated  in  the  histories  of  the 
.Alton  and  the  Rock  Island. 


7 


Railroads  From  the  Investor’s  Viewpoint 


But  of  more  general  and  wider  interest  is  the  change 
from  weakness,  and  even  bankruptcy,  to  great  strength. 
This  latter  is  the  history  of  such  splendid  properties  as  the 
Northern  Pacific,  the  Atchison,  the  Union  Pacific  and  the 
Southern  Pacific,  all  of  which  have  thrived  and  grown 
wealthy  as  the  new  country  into  which  they  have  reached 
has  developed. 

Again,  there  are  some  properties  which  have  not  had  to 
learn  the  folly  of  early  over-expansion  or  early  over-cap- 
italization, but  have  had  a steady  healthy  growth  with 
sane  financing  and  sane  operation  from  the  very  beginning. 
This  group  includes  such  great  properties  as  the  Pennsyl- 
vania, the  New  York  Central  Lines,  the  Louisville  and 
Nashville,  and  the  Illinois  Central. 

Again  there  is  that  group  of  roads  which  have  started 
in  weakness,  continued  in  weakness  and  now  remain  in 
weakness.  The  Erie,  the  Wabash,  the  Missouri  Pacific, 
the  Frisco,  the  Seaboard  and  the  Mobile  and  Ohio  are  types 
of  this  group. 

Roads,  as  well  as  individuals,  do  not  stand  still.  His- 
tory shows  that  their  fortunes  are  constantly  either  as- 
cending or  descending.  As  the  country  has  grown  and 
population  and  industry  have  shifted,  the  fortunes  of  the 
railroad  companies  have  shifted.  In  the  early  days  one 
hundred  miles  of  line  was  considered  a maximum  for  effi- 
cient operation,  and  this  remained  the  standard  up  to  about 
1870.  About  that  time  the  Illinois  Central,  with  a mileage 
of  perhaps  700  miles  was  considered,  and  actually  was,  one 
of  the  greatest  railroad  systems  in  the  world.  We  believe 
the  figures  show  that  until  after  the  Civil  War,  with  per- 
haps one  or  two  exceptions,  there  was  no  railroad  in  the 
country  with  a mileage  of  over  1,000  miles.  It  is  interesting 
to  note  that  the  Chicago  and  Northwestern  Road  operated 
with  only  a little  over  100  miles  of  road  almost  up  to  1860. 
By  1866  this  had  grown  to  only  about  500  miles.  It  is 
stated  that  in  traveling  from  the  Mississippi  River  to  New 
York  before  the  Civil  War,  it  was  necessary  to  change  cars 
at  least  seven  times.  Of  course,  as  the  country  grew,  such 
small  transportation  units  made  for  great  inconvenience  in 
traveling  and  for  this  reason,  among  others,  consolidation 
began  to  be  effected. 


8 


Federal  Securities  Corporation 


The  first  period  of  real  consolidation  of  railroads  was 
the  twenty  years  from  1870  to  1890,  at  which  latter  date 
the  maximum  length  of  line  was  about  5,000  miles.  About 
1880  the  Pennsylvania  had  approximately  4,000  miles  of 
line,  while  in  1886  the  Chicago  and  Northwestern,  which 
we  mentioned  above,  reached  about  3,500  miles  of  line, 
although  this  was  very  shortly  increased  to  about  5,000 
miles.  By  1889  the  Union  Pacific  owned  2,000  miles  of 
line  and  controlled  about  4,000  more. 

The  next  period  of  consolidation  was  in  the  twenty  years 
between  1890  and  1910,  during  which  time  systems  of  10,000 
miles  of  line  or  more  first  began  to  appear.  The  last  ten 
years  of  this  period  was  the  greatest  era  of  expansion  that 
this  country  has  ever  seen  or  probably  ever  will  see.  Dur- 
ing this  time  more  than  three  hundred  railroads  were  added 
to  those  that  were  already  operating,  but  so  many  con- 
solidations took  place  that  the  actual  number  of  roads 
operating  in  1910  was  only  829  as  compared  with  849  in 
1900.  This  shows  how  rapidly  the  various  operating  units 
in  the  country  were  combining  into  large  single  systems. 
This  tendency  toward  consolidation  was  checked  for  a 
time  during  the  years  of  depression  of  1893  to  1897,  when 
occasional  dismemberment  of  some  properties  took  place. 
The  Frisco,  for  example,  was  divorced  from  the  Atchison, 
and  the  Union  Pacific  lost  the  Oregon  Short  Line.  But 
out  of  the  chaos  of  this  period  developed  the  more  or  less 
permanent  operating  units  which  we  now  have  in  this 
country. 

The  figures  in  connection  with  the  consolidations  of  the 
period  from  1890  to  1910  are  quite  startling.  During  the 
four  years  before  the  panic  of  1903,  over  four  hundred  rail- 
roads, aggregating  about  32,000  miles  of  line,  were  merged 
or  consolidated.  During  this  period  also,  the  systems 
which  in  the  90’s  comprised  ten  thousand  miles  of  line  grew 
to  be  groups  which  owned  or  controlled  15,000  to  20,000 
miles  of  line.  It  is  interesting  that  in  the  space  of  a little 


9 


Railroads  From  the  Investor’s  Viewpoint 


over  one  year,  1899  to  1900,  over  25,000  miles  of  railroad 
were  absorbed  or  combined  in  one  fashion  or  another.  As 
there  are  now  about  200,000  miles  of  road  in  the  country,  we 
see  that  more  than  one-eighth  of  this  entire  mileage  was, 
during  the  space  of  a little  over  one  year,  absorbed  or 
combined  in  some  manner.  As  an  example  of  growth,  we 
might  mention  the  Rock  Island,  which  grew  from  3,800 
miles  in  1901  to  15,000  miles  about  five  years  later.  But  the 
really  spectacular  growth  was  that  of  the  Union  Pacific. 
This  road  in  1906  actually  controlled  25,000  miles  of  line 
and  through  stock  ownership  Mr.  Harriman  had  influence 
over  30,000  miles  besides. 

This  spirit  of  combination  grew  to  be  so  strong  and 
seemed  to  be  so  permanent  that  for  a time  it  appeared  as 
though  the  traffic  of  the  country  was  definitely  and  for  all 
time  to  be  divided  between  certain  groups  of  roads  which 
seemed  to  have  understandings  with  each  other.  But  the 
attitude  of  the  public  largely  counteracted  this  influence 
and  culminated  in  the  Sherman  Anti-Trust  Act.  The  con- 
solidations which  had  been  built  up,  began  about  1910  to 
go  to  pieces.  The  Gould  group,  the  result  of  an  ambitious 
but  weakly  constructed  plan  for  an  ocean-to-ocean  system, 
fell  apart  because  of  lack  of  strength.  The  Rock  Island 
came  to  grief,  and  its  holding  companies  were  dissolved 
because  of  internal  corruption.  The  Union  Pacific  and  the 
New  England  monopolies  were  dissolved  by  mandate  of 
the  Department  of  Justice  of  the  United  States.  It  is  not 
possible  to  elaborate  within  the  scope  of  this  pamphlet,  but 
the  steps  by  which  these  various  systems  grew  into  being 
and  into  a position  of  power  and  then  into  a period  of  de- 
cline are  most  interesting.  The  story  of  the  rise  and  fall 
of  the  New  England  monopoly;  the  working  out  of  the 
problems  of  the  Pennsylvania  and  New  York  Central  in 
furthering  traffic  amity  between  themselves  and  their  com- 
petitors in  their  territory;  the  tremendous  expansion  of 
the  Union  Pacific  system  under  E.  H.  Harriman,  its  final 
dissolution  and  its  subsequent  development  under  saner 
methods,  these  are  all  most  interesting  stories  but  involve 
too  much  detail  to  be  set  down  here. 


10 


Federal  Securities  Corporation 


Msi]niipiLiilsi{tn©ini 

There  are,  however,  some  phases  of  the  history  of  the 
railroads  up  to  the  period  of  Government  control,  which 
it  seems  necessary  to  dwell  on  a little  further.  At  one 
time  or  another  various  roads  have  been  made  a football 
of  by  the  men  who  were  running  them  for  their  own  per- 
sonal gains.  One  of  the  best  examples  of  this  practice  was 
the  manipulation  of  the  Rock  Island  lines  by  the  Moore- 
Reid  interests. 

The  Rock  Island  originally  was  one  of  the  fine  prop- 
erties of  the  country  and  had  paid  dividends  on  its  stock 
from  about  the  time  of  the  Civil  War  up  to  the  time 
when  it  was  taken  over  by  the  Moore-Reid  interests  in  1902. 
At  that  time  they  purchased  a large  amount  of  the  out- 
standing stock  of  the  Chicago,  Rock  Island  & Pacific  Rail- 
zuay  Company  in  the  open  market  in  order  to  gain  control. 
Their  idea  was  to  manipulate  this  property  in  such  a way 
that  they  could  make  money  out  of  it  for  an  inside  ring, 
and  still  to  maintain  control  of  the  property  without  ac- 
tually having  any  large  amount  of  investment  in  it.  The 
capital  stock  of  the  Raihvay  Company,  which  was  the  oper- 
ating company,  amounting  to  about  $75,000,000,  was 
pledged  as  security  for  a like  amount  of  Collateral  Trust 
Bonds  of  the  Chicago,  Rock  Island  & Pacific  Railroad 
Company,  which  was  organized  to  own  the  stock  of  the 
Railway  company.  Capitalized  at  $145,000,000,  it  in  turn 
was  owned  through  exchange  of  shares  by  the  Rock  Island 
Company,  chartered  with  a capital  stock  of  $139,000,000. 
Thus  all  three  of  the  companies  were  bound  together  and 
by  marketing  the  Collateral  Trust  Bonds  of  the  Railroad 
company,  the  promoters  reimbursed  themselves  for  their 
outlay  in  buying  up  the  stock  of  the  operating  or  Railway 
company.  The  control  of  the  whole  structure  lay  in  a 
small  amount  of  the  Rock  Island  Company  Preferred  Stock, 
owned  by  the  Moore-Reid  interests. 

The  road  about  4,000  miles  long  at  the  time  of  acquisi- 
tion was  immediately  expanded  to  about  15,000  miles  and  in 
the  effort  to  pay  dividends  was  allowed  to  go  to  pieces,  with 

the  result  that  in  1914  the  system  went  into  receivership. 

LIBRARY 

UNIVERSITY  jOF  ILLINOIS 
URBANA 


Railroads  From  the  Investor’s  Viewpoint 


Over-capitalized,  over-expanded,  highly  manipulated  and 
under-maintained,  there  could  have  been  no  other  result. 
The  Preferred  Stock  of  the  Rock  Island  Company,  which 
had  been  originally  quoted  around  86  had  by  1908  reached 
about  20  and  six  years  later  was  quoted  1^. 

There  were  numerous  other  instances  of  this  same  char- 
acter in  the  affairs  of  other  lines  of  the  country.  At  various 
periods  speculation  in  the  railroad  shares  was  tremendous. 
For  example,  in  1901  the  capital  stock  of  the  Union  Pacific 
was  sold  twenty-one  times  over,  of  the  St.  Paul  twenty-two 
times  over,  of  the  Atchison  twelve  times,  of  the  Erie  and 
the  Wabash  ten  times,  while  in  one  single  day  in  April, 
1901,  652,000  shares  of  the  Union  Pacific  changed  hands  in  a 
single  session  of  the  Stock  Exchange.  This  represents 
more  than  half  of  the  entire  capital  stock  of  this  company. 
Again,  in  1906,  there  was  another  frenzied  period  of  the 
same  character,  when  during  the  year  43,000,000  shares  of 
Reading  Common  Stock  changed  hands.  In  fact,  the  capital 
stock  of  the  Reading  in  the  past  has  always  been  a specu- 
lative football.  In  1904  its  Common  stock  was  handled 
seven  and  one-half  times  over,  in  1905  sixteen  times,  and 
in  1906  (the  period  mentioned  above)  thirty-one  times.  It 
is  reported  that  during  the  third  week  of  April,  1909,  the 
sales  of  its  Common  stock  equaled  one-half  of  the  total 
outstanding. 

Various  methods  have  been  used  by  insiders  at  different 
times  with  the  purpose  of  manipulating  markets  so  as  to 
make  profits  for  themselves.  Prior  to  the  jurisdiction  of 
the  Interstate  Commerce  Commission,  it  was  always  pos- 
sible to  defer  the  customary  outlays  for  maintenance,  etc., 
for  the  purpose  of  continuing  to  pay  dividends.  Orders  to 
get  traffic  at  any  cost  would  be  sent  out,  thereby  increasing 
the  revenues  of  the  company  without  putting  the  proper 
amount  back  into  the  road. 

Such  tactics  were  charged  against  the  Atchison  in  1890 
at  the  time  when  Baring  Brothers  were  heavily  inter- 
ested in  this  property.  In  the  early  90’s  the  B.  & O.  also 
was  said  to  have  been  guilty  of  deliberate  falsifications  of 
accounts  by  insiders  in  order  to  create  a market  to  unload 
securities  at  high  prices.  In  the  case  of  the  B.  & O.,  for 


12 


Federal  Securities  Corporation 


example,  during  seven  years  dividends  amounting  to  about 
$6, 000, OCX)  had  been  paid  out,  whereas  a later  accounting 
showed  that  probably  less  than  $1,000,000  had  actually  been 
earned. 

We  are  all  familiar  with  the  various  pools  that  have  at 
one  time  or  another  operated  in  railroad  securities.  The 
famous  Keene  pool  of  1902-3,  which  was  an  attempt  to  pur- 
chase a large  block  of  stock  of  the  Southern  Pacific  and  by 
control  of  the  Directorate  to  force  the  management  to 
stop  its  policy  of  putting  money  back  into  the  property  so 
that  higher  earnings  would  be  reported  and  thus  afiford  the 
pool  the  opportunity  of  unloading  the  stock  on  the  public 
at  increased  prices. 

There  was  also  the  famous  Gates  pool,  which  at  the 
time  when  the  L.  & N.  was  about  to  issue  $5,000,000  of  new 
stock,  purchased'  a majority  of  the  outstanding  shares  of 
this  road  and  forced  the  Morgan  interests  to  repurchase 
this  stock  from  them  at  a handsome  profit.  The  practice  of 
padding  or  starving  income  statements  has  in  the  past  been 
one  of  the  most  prolific  sources  of  profit  to  insiders  in  the 
case  of  speculatively  managed  railroads,  but  under  the 
supervision  of  the  Interstate  Commerce  Commission  such 
manipulation  is  now  practically  impossible. 


Stock  Watermg 

Another  practice  which  has  at  various  times  in  the  past 
been  prevalent,  has  been  that  of  stock  watering  or  the 
issuance  of  stock  for  purely  speculative  purposes.  For  ex- 
ample, the  Erie  between  1868  and  1872  had  its  capital  stock 
increased  from  $17,000,CX)0  to  $78,000,000  primarily  for 
manipulation  in  the  market.  It  has  been  said  that  convert- 
ible bonds  were  put  out  by  this  road  during  these  years  to 
such  an  extent  that  they  were  limited  only  by  the  capacity 
of  the  printing  presses. 

We  have  already  reviewed  the  situation  of  the  Chicago, 
Rock  Island  & Pacific  Railway  Company  and  its  two  hold- 
ing companies,  showing  the  tremendous  inflation  of  the 
capital  account.  The  total  capitalization  of  these  three 


13 


Railroads  From  the  Investor’s  Viewpoint 


companies  amounted  to  $1,500,000,000  which  was  controlled 
by  a little  more  than  $5,000,000  of  Preferred  Stock. 

Unscrupulous  or  designing  managers  of  properties  have 
been  able  so  to  manipulate  the  affairs  of  their  roads  in 
the  past  that  the  burden  on  the  property  in  the  way  of 
interest  charges  became  absolutely  impossible.  The  New 
Haven,  which  we  have  mentioned  before,  is  a case  in 
point.  Within  nine  years  to  1912,  the  outstanding  securi- 
ties of  this  property  were  increased  from  $93,000,000  to 
$417,000,000,  although  only  fifty  miles  of  line  were  added 
during  that  time.  New  issues  of  stock  and  bonds  during 
this  period  brought  in  in  cash  $340,000,000,  most  of  which 
was  invested  in  properties  outside  the  sphere  of  the  rail- 
road’s own  activities — namely,  in  trolley  companies,  steam- 
ship lines,  electric  light  and  power  plants,  docks  and  water 
frontage.  This  situation  was  brought  about  by  an  absolute 
disregard  of  the  interests  of  the  public  or  of  the  share- 
holders of  the  road,  and  was  largely  planned  for  the  benefit 
of  certain  insiders.  So  bad  did  this  situation  finally  become 
that  the  Federal  authorities  were  in  1914  forced  to  inter- 
vene and  order  the  dissolution  of  these  various  properties. 

The  most  famous  instance  of  all,  which  illustrates  prob- 
ably every  abuse  possible,  is  the  manipulation  by  E.  H. 
Harriman  of  the  Chicago  & Alton  Railroad.  For  years  this 
property  had  been  considered  one  of  the  finest  and  best 
managed  in  the  country.  Over  a space  of  about  seven  years 
beginning  in  1898,  the  capitalization  of  this  road  was  ex- 
panded from  about  $34,000,000  to  about  $115,000,000, 
although  according  to  the  accounts  of  the  road  only  about 
$18,000,000  had  been  expended  in  improvements  and  addi- 
tions to  the  property.  It  seems,  therefore,  that  securities 
totaling  over  $62,000,000  were  sold  to  the  public  during 
that  time  without  one  dollar  of  consideration.  This  amount 
added  practically  $66,000  a mile  to  the  capitalization  of  the 
road  and  burdened  it  with  a debt  from  which  it  has  never 
recovered.  The  road  was  passed  from  syndicate  to  syndi- 
cate, in  the  course  of  each  step  of  which  insiders  made  a 
profit,  and  it  was  finally  sold  to  the  Rock  Island,  who  could 
ill  afford  to  handle  a property  so  tremendously  burdened. 


14 


Federal  Securities  Corporation 


In  the  past,  methods  which  were  permitted  in  keeping* 
accounts  afforded  very  favorable  opportunities  for  increases 
in  capitalization  and  for  other  manipulations  by  insiders. 
Happily  not  all  of  the  railroads  in  the  country  have  fol- 
lowed these  practices.  Many  have  liberally  utilized  their 
surplus  earnings  to  build  up  their  properties.  The  Pennsyl- 
vania for  example  for  years  followed  the  “dollar  for  dollar” 
policy  of  spending  literally  one-half  of  its  income  for 
maintenance,  upkeep  and  betterments.  During  the  period 
between  1887  and  1911,  the  Pennsylvania  put  back  into  its 
lines  east  of  Pittsburg,  $262,000,000  out  of  earnings. 

The  Chicago  & Northwestern  during  twenty  years  up 
to  1913  set  aside  $77,000,000  out  of  its  net  income  of  about 
$200,000,000  and  put  it  either  into  improvements  or  carried 
it  over  to  surplus.  In  the  South,  the  Louisville  & Nashville 
took  $18,000,000  out  of  its  earnings  in  eight  years  prior  to 
1907  to  put  back  into  its  property.  This  amount  was  equal 
to  over  30%  on  its  capital  stock  while  the  total  surplus 
built  up  to  1912  was  equal  to  90%  of  the  capital  stock. 

The  roads  which  have  followed  this  character  of  policy, 
keeping  themselves  clear  of  the  evils  of  over-capitalization 
and  manipulation,  have  continued  to  thrive  and  to  grow, 
and,  fortunately,  as  time  has  gone  along  fewer  and  fewer 
roads  have  practiced  these  evils.  Those  that  have,  have 
learned  through  bitter  experience  that  no  road  can  live 
and  grow  under  such  practices  and  that  only  with  conserva- 
tive capitalization  and  sound,  sane  operating  methods  may 
a road  build  for  itself  a strong  place  among  the  carriers  of 
the  country. 

Roads,  seemingly,  have  had  to  learn  these  things  by 
experience,  just  like  individuals,  but  when  the  lesson  has 
once  been  learned,  its  good  effects  have  usually  been  lasting. 
Some  of  the  strongest  properties  in  the  country  today  are 
those  that  in  the  past  have  been  guilty  of  the  worst  prac- 
tices and  even  become  involved  in  the  most  serious  diffi- 
culties. We  must  not  take  these  records  too  seriously  in 
considering  the  railroads  of  today,  because  such  practices 
are  next  to  impossible  under  the  jurisdiction  of  the  Inter- 
state Commerce  Commission.  However,  since  we  are  re- 


15 


Railroads  From  the  Investor’s  Viewpoint 


viewing  the  past  history  of  the  railroads  of  the  United 
States,  we  must  face  the  facts  as  they  are,  even  while  we 
realize  that  in  most  cases  the  lurid  spots  of  the  past  are  the 
very  foundation  of  the  strength  of  the  present.  Many  a 
road  is  prosperous  and  thriving  today  only  because  diffi- 
culty in  the  past  (and  even  receivership  and  foreclosure) 
has  forced  the  managers  to  a basis  of  sound  financing  and 
efficient  operation.  It  is  only  when  roads  have  practiced 
bad  methods  that  they  have  become  involved  in  trouble ; 
but  since  so  many  of  them  have  had  to  learn  their  lesson, 
a brief  survey  of  the  financial  difficulties  that  they  have 
gone  through  must  be  considered  if  we  are  to  get  a correct 
idea  of  the  situation. 


At  one  time  or  another  practically  one-half  of  the  rail- 
roads of  the  country  have  been  in  receivership.  That  is  a 
startling  statement.  Receiverships  and  re-organizations  in 
the  railroads  of  the  United  States  have  been  brought  on 
usually  by  one  or  more  of  the  evils  which  have  been  dis- 
cussed above. 

The  aggregate  number  of  receiverships  and  the  aggre- 
gate mileage  involved  reach  astounding  totals.  Certain 
figures  that  we  have  seen  show  that  since  1875  over 
$8,000,000,000  of  stocks  and  bonds  of  the  railroad  companies 
of  the  United  States  have  gone  through  receivership 
manipulation,  while  over  $7,000,000,000  have  actually  come 
under  foreclosure  sale.  This  is  a total  of  over  $15,000,000,000 
which  is  almost  equal  to  the  total  aggregate  valuation  of  all 
the  railroads  allowed  by  the  Interstate  Commerce  Com- 
mission in  their  recent  decision.  (This  allowed  value  was 
about  $18,000,000,000.)  As  the  present  total  capitalization 
in  stocks  and  bonds  of  all  the  railroads  in  the  United  States 
is  something  over  $16,000,000,000,  it  will  be  seen  that  there 
has  been  in  receivership  during  the  past  40  years  an  amount 
of  securities  practically  equal  to  the  present  capitalization 
of  the  railroads  and  almost  equal  to  their  present  physical 
value.  Moreover  the  mileage  which  has  been  aflected  by 
foreclosure  and  receivership  since  1875  is,  roughly  speaking. 


16 


Federal  Securities  Corporation 


about  equal  to  the  present  total  mileage  of  the  United 
States. 

Overexpansion — In  the  early  days  of  railroad  con- 
struction, both  before  and  after  the  Civil  War,  vv^hen  Con- 
gress and  the  State  legislatures  'were  recklessly  voting 
land  and  money  appropriations  for  railroad  aid  and  con- 
struction, expansion  was  quite  a natural  result.  In  many 
cases  where  land  grants  were  given  and  subsidies  voted, 
the  promoters  were  unscrupulous  men  who  did  not  stop  to 
consider  whether  the  population  of  a district  made  a rail- 
road a necessity ; their  only  idea  was  to  get  the  line  con- 
structed that  they  might  gain  the  benefit  of  the  appropria- 
tions and  of  the  land  grants.  This  was  true  in  the  case  of 
the  Northern  Pacific,  which  under  Jay  Cook,  expanded  too 
rapidly  in  a sparsely  settled  territory  and  in  1873  came  to 
grief.  This  was  the  trouble  also  with  the  Atchison,  Topeka 
& Santa  Fe,  which  was  forced  into  receivership  in  1887  and 
again  went  to  pieces  in  1893.  In  1893  also,  the  Northern 
Pacific  was  forced  into  its  second  receivership  largely  be- 
cause of  over-expansion  in  branch  lines  which  were  un- 
profitable because  they  ran  into  unsettled  territory  and 
ended  nowhere.  The  Atchison,  in  1871  had  only  471  miles 
of  line,  but  by  1888  had  expanded  to  7,000  miles,  2,700  of 
which  had  been  constructed  or  acquired  in  two  years  in  an 
ambitious  attempt  to  reach  Chicago,  the  Pacific  Coast,  and 
the  Gulf  of  Mexico  at  one  and  the  same  time  to  make  a 
trans-continental  railroad  out  of  a local  line. 

Overcapitalization — Over-expansion,  however,  was  not 
the  only  factor  that  brought  grief  to  the  roads  that  we 
have  mentioned.  In  all  of  these  cases,  and  in  practically 
each  one  where  over-expansion  has  had  its  efifect,  a sec- 
ond influence  has  operated  to  cause  receivership  and  re- 
organization. This  is  overcapitalization.  We  have  seen 
how  this  evil  brought  ruin  to  the  Rock  Island  system  and 
we  have  briefly  reviewed  the  tremendous  overcapitaliza- 
tion of  the  Chicago  & Alton  within  the  space  of  a very 
few  years,  which  brought  this  splendid  property  to  a condi- 
tion of  weakness  from  which  it  has  never  recovered.  We 
all  are  familiar  with  the  receivership  of  the  Cincinnati, 


17 


Railroads  From  the  Investor’s  Viewpoint 


Hamilton  & Dayton  in  recent  years,  but  we  may  not  all 
know  that  the  difficulties  of  this  road  were  brought  on 
l^ecause  in  two  years  the  bonded  indebtedness  of  the  com- 
pany was  piled  up  from  $12,000,000  to  $48,000,000,  while  its 
floating  debt,  which  at  the  beginning  of  that  two  year 
period  was  almost  nothing,  grew  in  the  end  to  about 
$10,000,000. 

In  overcapitalization,  of  course,  it  is  not  so  much  the 
excessive  amount  of  Preferred  or  Common  stock  which 
brings  on  trouble,  as  it  is  an  overloading  of  bonds,  which 
means  an  overloading  of  fixed  charges.  Weak  roads  like 
the  Wabash,  for  example,  have  had  almost  no  chance  to 
get  into  a position  of  strength  because  of  the  fact  that  they 
were  so  loaded  with  fixed  charges  that  no  margin  of  surplus 
was  left  for  development  or  upkeep  of  the  property.  The 
Erie,  which  is  one  of  the  classics  in  the  history  of  receiver- 
ships of  railroads  in  the  United  States,  has  come  in  and 
gone  out  of  receivership  and  foreclosure  sale  more  times 
than  any  other  road  in  the  country,  largely  because  the 
men  who  were  in  power  were  robbing  the  road  by  piling 
up  indebtedness,  usually  in  the  form  of  collateral  trust 
bonds,  with  little  or  no  security  back  of  them.  This  road 
again  and  again  Avas  guilty  of  the  practice  of  issuing  new 
oblig'ations  in  order  to  provide  funds  to  take  care  of  the 
interest  on  the  old  ones;  so  that  in  1857,  in  1873,  in  1884, 
and  a fourth  time  in  1893,  the  road  went  into  receivers’ 
hands,  and  in  1908  escaped  a fifth  time  only  by  the  slightest 
possible  kind  of  margin.  Other  instances  in  more  recent 
times  are  the  Missouri  Pacific  and  the  Frisco,  which  were 
forced  into  receivership  because  of  overcapitalization  and 
of  increasing  fixed  obligations  until  they  were  more  than 
the  earnings  of  the  roads  could  possibly  bear. 

Fraud  and  Deception — The  third  cause  for  receiver- 
ship, a cause  which  goes  hand  in  hand  with  the  other 
two  which  we  have  just  mentioned,  is  fraud  and  deception, 
coupled  usually  with  speculation.  In  the  case  of  the 
Atchison  receivership,  for  example,  income  had  been  over- 
stated for  years.  The  Baltimore  & Ohio,  too,  was  forced 
to  suffer  through  the  practice  of  its  owners  in  falsifying 


18 


Federal  Securities  Corporation 


income  statements;  while  the  real  situation  in  connection 
with  the  Chicago  & Alton  during  the  time  of  the  Harriman 
control  was  not  given  out  to  the  public  and  it  would  seem 
was  not  even  known  to  the  Rock  Island  at  the  time  that 
the  latter  purchased  control. 

It  is  said  that  deception  had  its  part  in  almost  every  rail- 
road that  was  ever  owned  or  controlled  by  Jay  Gould.  The 
troubles  of  the  Gould  roads,  of  course,  have  been  many. 
Practically  every  one  of  them  except  the  Denver  & Rio 
Grande,  has  gone  into  receivership,  and  even  this  road  is  at 
present  in  a very  precarious  position.  Starting  from  the 
West,  these  Gould  roads  include  the  Western  Pacific,  the 
Missouri  Pacific,  the  WMbash,  the  Wabash  Pittsburg  Term- 
inal, and  the  Wheeling  and  Lake  Erie,  all  of  which  have 
known  receivership.  We  all  know  of  the  ambitious  attempt 
which  he  made  to  combine  these  parts  into  a trans-conti- 
nental system  running  from  ocean  to  ocean,  but  which  went 
to  pieces  in  1893. 


P(Birn©(dli  ©{p  D©pir©§in©im 

There  are  certain  outstanding  periods  in  the  history  of 
the  railroads.  First,  there  is  the  panic  of  1873  to  1877, 
before  the  modern  railroad  was  evolved,  when  over  ten  per 
cent  of  the  mileage  of  the  country  went  into  receivership, 
and  one-fourth  of  the  total  bonded  indebtedness  defaulted 
on  its  interest.  Second,  in  the  panic  year  of  1883,  and 
over  a period  lasting  until  1887,  another  large  group  of 
roads  went  into  receivership.  At  this  time  eleven  thousand 
miles  of  line  were  taken  over  by  the  receivers.  Third,  the 
panic  years  of  1893  to  1895,  when  the  number  and  extent 
of  receiverships  broke  all  records.  Statistics  show  that  on 
June  30,  1894,  192  companies  were  in  the  hands  of  receivers, 
while  the  total  mileage  involved  by  the  companies  was  in 
excess  of  40,000  miles.  The  total  amount  of  capitalization — 
namely,  of  stocks  and  bonds — of  these  roads  aggregated 
about  $2,500,000,000,  or  about  one-quarter  of  the  total  rail- 
road capitalization  at  that  time.  Fourth,  in  1907,  a period 
of  financial  distress,  18,000  miles  of  road  went  into  receiver- 
Gii]).  Fifth,  we  all  remember  the  time  of  apprehension  of 


19 


Railroads  From  the  Investor’s  Viewpoint 


1913  and  1914,  when  about  $600,000,000  of  notes  and  bonds 
were  involved  in  financial  difficulties. 

Of  course,  in  practically  every  one  of  these  cases  the 
weakness  in  the  road  was  there  before  the  financial  strin- 
gency came  on.  A period  of  financial  distress  merely 
crystallized  the  situation  and  hastened  a result  which  in 
many  cases  undoubtedly  would  have  followed  in  regular 
course.  In  all  of  these  situations,  the  primary  cause  of 
failure  was  inability  of  the  railroads  to  pay  their  fixed 
charges  out  of  earnings. 


Similarly,  in  reorganization,  the  problem  has  been  to 
reduce  the  funded  indebtedness  either  in  par  value  amount 
or  in  interest  rate,  so  that  the  total  obligations  of  the  com- 
pany would  be  within  its  earning  power.  This  has  not 
always  been  done  in  receivership.  In  the  first  Atchison 
receivership,  for  example,  and  also  in  the  first  Northern 
Pacific  receivership,  the  amount  of  funded  indebtedness  was 
not  cut  down  nor  were  the  interest  charges  reduced.  As  a 
matter  of  fact,  in  the  Northern  Pacific  case,  the  amount 
was  increased  instead.  The  result  was  that  both  of  these 
roads  again  went  into  receivership,  when  the  financial  de- 
pression of  1893-1895  came  upon  the  country. 

Most  of  the  reorganizations,  however,  have  followed  the 
basic  principle  of  reducing  the  fixed  charges.  Some  have 
accomplished  the  purpose  by  drastically  reducing  the 
amount  of  funded  indebtedness  outstanding  per  mile. 
Others  have  not  reduced  the  par  value  amount  of  funded 
indebtedness  but  have  reduced  the  interest  rate,  as  in  the 
case  of  the  second  Northern  Pacific  receivership,  which  cut 
the  interest  charges  in  two  without  any  decrease  in  the 
funded  indebtedness.  Others  again  have  brought  about  the 
same  result  not  by  reducing  the  interest  charges,  but  by 
making  a part  of  the  interest  charges  payable  only  if  earned. 
In  the  second  Atchison  reorganization  this  was  done  and 
part  of  the  bonds  which  were  re-issued  to  the  holders  of 
the  old  obligation  were  made  Adjustment  Income  4s,  the 
interest  on  which  was  payable  only  if  earned. 


20 


Federal  Securities  Corporation 


Sftiroinig  M©a(dl§ 

We  have  laid  a good  deal  of  stress  on  the  various  diffi- 
culties which  railroad  operation  has  encountered  in  the 
past,  but  we  wish  also  to  emphasize  the  fact  that  these 
weaknesses  have  not  been  prevalent  among  the  roads  as  a 
class.  It  is  said  that  the  annals  of  a peaceful  nation  are 
short.  Similarly  we  can  sum  up  in  a few  words  the  story  of 
those  roads  which  were  started  under  sane  principles  of 
finance  and  operation,  have  continued  under  the  same  prin- 
ciples and  today  remain  secure  properties.  The  weak  roads, 
poorly  financed,  overexpanded  and  subject  to  manipulation, 
have  been  up  and  down  and  much  must  be  said  to  cover 
their  varied  history.  The  strong  roads  on  the  other  hand 
do  not  figure  in  this  history,  but  their  story  is  one  of  gradual 
growth  in  mileage  and  prosperity.  They  have  expanded 
slowly  and  at  the  right  times.  As  the  territory  has  grown 
and  the  industries  within  it  have  thrived,  the  roads  have 
been  expanded  and  have  prospered.  They  have  put  money 
back  into  the  property  at  the  right  times,  so  that  their  road 
bed  and  equipment  has  been  properly  maintained.  Again 
they  have  not  been  guilty  of  overexpansion. 

We  all  are  familiar  with  the  names  of  these  roads. 
There  are  outstanding  systems  of  this  character  in  the 
East,  in  the  West  and  in  the  South.  In  the  East  we  have 
the  New  York  Central,  which  is  merely  an  end  to  end 
consolidation  of  a great  number  of  roads  which  were  built 
by  various  parties.  This  property  always  has  and  does 
today  enjoy  a splendid  reputation.  Dividends  have  been 
paid  constantly  since  1870.  The  Lake  Shore  which  is  part 
of  this  system  is  considered  one  of  the  finest  pieces  of  rail- 
road in  the  country.  The  Michigan  Central  is  also  a 
splendid  property  and  has  paid  continuous  dividends  over 
a long  period  of  years.  The  Pennsylvania  is  an  example 
of  a road  which  has  grown  and  expanded  under  conservative 
principles  of  capitalization  as  the  territory  and  as  industries 
within  the  territory  have  grown.  We  all  know  that  this 
property  has  paid  dividends  continually  since  1856,  and 
that  the  management,  decade  after  decade,  has  stood  out 
for  their  principle  of  maintaining  the  efficiency  of  the  prop- 


21 


Railroads  From  the  Investor’s  Viewpoint 


erty  regardless  of  stock  market  or  other  influences.  The 
Norfolk  & Western,  which  is  practically  a Pennsylvania 
property,  as  the  latter  owns  over  $38,000,000  of  its  common 
stock,  is  also  a road  of  this  same  class,  which  enjoys  a 
splendid  reputation. 

In  the  Middle  West  and  the  West,  one  of  the  outstanding 
properties  is  the  Chicago,  Burlington  and  Quincy.  This 
road  begun  as  a branch  line  between  Chicago  and  Aurora  in 
1849,  has  grown  gradually  and  has  built  feeders  in  its  terri- 
tory as  the  population  has  grown.  Today  this  road  is  called 
the  “mother  of  railroad  presidents”  because  it  has  produced 
so  many,  and  enjoys  the  reputation  of  being  one  of  the  flnest 
pieces  of  property  in  the  country.  Its  principle  of  expansion 
was  to  build  new  lines  in  the  territory  only  as  the  popula- 
tion warranted.  The  Great  Northern  on  the  other  hand, 
which  with  the  Northern  Paciflc  jointly  controls  the  C.  B. 
& O.,  under  Mr.  Hill  adopted  a little  different  method  of 
expansion.  Mr.  Hill’s  policy  was  to  build  a road  in  a 
territory  which  he  was  sure  would  be  productive,  and  then 
pull  the  population  in  after  him.  We  all  know  what  a 
tremendous  success  Mr.  Hill  made  of  a defunct  railroad 
company  which  he  and  his  associates  purchased  in  1878 
and  which  he  with  his  foresight  and  judgment  expanded 
carefully  and  conservatively  into  one  of  the  splendid 
systems  of  the  country.  In  point  of  capitalization  per  mile, 
the  Great  Northern  and  C.  B.  & O.  are  among  the  most 
conservative  in  the  country.  The  Chicago  & North- 
western is  another  road  whose  affairs  have  been  conducted 
under  a sane  conservative  policy,  which  has  never  since 
very  early  times  been  in  difficulties.  Dividends  have  been 
paid  by  this  company  almost  continually  since  1864;  to  date 
over  $70,000,000  have  been  paid  in  preferred  dividends  to 
stockholders  and  over  $120,000,000  in  common  dividends. 
The  Chicago,  Milwaukee  & St.  Paul  also  enjoyed  a similar 
reputation  for  a great  many  years,  but  more  recently  this 
property  has  suffered  from  one  reason  or  another.  Its 
principles  of  capitalization  are  not  as  conservative  as  the 
other  roads  which  we  have  mentioned,  and  it  has  been  said 
that  the  building  of  its  Puget  Sound  extension  was  an  ex- 


22 


Federal  Securities  Corporation 


pansion  which  was  not  warranted  at  the  time.  In  any  case 
this  road  which  for  years  has  been  a strong  one,  is  today 
struggling  to  keep  its  place. 

In  the  South  also  there  are  two  splendid  properties. 
The  Illinois  Central,  the  outstanding  one  of  these,  has  un- 
interruptedly paid  dividends  since  1863  and  the  Louisville 
& Nashville  with  the  exception  of  eight  years  in  its  early 
history  and  five  years  in  the  90’s,  has  also  paid  dividends 
since  1864.  We  have  previously  mentioned  in  this  pamphlet 
how  these  two  roads  have  maintained  the  efficiency  of.  their 
properties  by  reinvesting  earnings  in  road  bed  and  equip- 
ment. 

There  are  other  roads  which  today  occupy  a very  strong 
position  into  which  they  have  grown  only  after  they  have 
encountered  difficulties  in  the  past.  The  Norfolk  & Western 
is  really  a road  of  this  character,  as  it  experienced  receiver- 
ship early  in  its  history.  We  have  previously  mentioned 
the  Northern  Pacific,  Atchison,  Union  Pacific  and  South- 
ern Pacific,  all  four  of  which  are  without  question  among 
the  outstanding  roads  of  the  country.  Under  Mr.  Harri- 
man,  the  Union  and  Southern  Pacific  systems,  which 
were  practically  bankrupt  at  the  time  he  took  them  over, 
were  developed  into  wonderful  properties  physically  by  the 
investment  of  millions  in  road  bed  and  equipment.  Today 
the  Union  Pacific  is  so  prosperous  that  it  has  been  said  it 
could  stop  running  its  trains  entirely  and  still  continue  to 
pay  the  interest  on  its  funded  debt  out  of  the  earnings  from 
outside  investments.  We  can  multiply  details  of  this  char- 
acter, but  in  a treatise  of  this  kind  it  is  possible  only  to  draw 
outlines  of  strength  and  weakness.  The  past  history  of  any 
of  these  properties  must  be  studied  in  detail  really  to 
understand  the  situation  in  regard  to  each  company. 


23 


Railroads  From  the  Investor’s  Viewpoint 


JAMES  J.  HILL 


24 


Federal  Securities  Corporation 


II 

EECEMT  HISTORY 
Siftuaaftnomi  Dimifmg  ftEe  W@irM  War 

This  brings  our  story  down  to  the  time  that  the  United 
States  entered  the  War.  We  are  all  more  or  less  familiar 
with  the  problems  which  the  railroads  were  asked  to  face  at 
that  time.  We  know  of  the  labor  situation  and  the  increas- 
ing scale  of  prices  which  confronted  railroads  in  1917  as  a 
result  of  the  world  war  in  Europe.  Traffic,  of  course,  had 
been  tremendous  during  1916,  which  was  one  of  the  most 
prosperous  years  in  the  annals  of  railroad  history  of  the 
United  States.  This  prosperity  continued  during  the  early 
part  of  1917,  but  the  situation  changed  at  the  time  of  our 
entr}^  into  the  war. 

Notwithstanding  the  large  volume  of  traffic  which  the 
roads  were  carrying,  the  railroad  situation  (due  to  the  rising 
costs  of  labor,  of  material  and  of  money)  in  the  Spring  of 
1917  became  acute.  There  was  a large  shortage  of  equip- 
ment of  all  kinds  due  to  the  heavy  traffic,  as  well  as  an 
insufficient  and  inefficient  labor  supply  at  high  costs.  As 
a result,  the  margin  of  net  earnings  showed  a declining 
tendency,  and  there  appeared  to  be  an  impending  demoral- 
ization of  railroad  credit.  In  addition,  the  political  attitude 
toward  the  railroads  was  most  uncertain,  a condition  that 
added  further  perplexities  to  the  situation.  The  net  result 
was  that  during  the  nine  months  of  war  preceding  Govern- 
ment operation  of  the  railroads,  the  situation  was  uncertain 
and  critical. 

It  was  recognized  by  the  Government,  the  railroad  com- 
panies, and  the  public  at  large  that,  upon  our  entrance  into 
the  war,  the  interests  of  the  railroad  companies  should  be 
made  subservient  to  the  general  welfare  of  the  country  and 
to  the  plan  of  moving  all  things  toward  a favorable  termin- 
ation of  the  war  as  early  as  possible.  The  companies  volun- 
tarily surrendered  their  individual  initiative  and  independ- 
ence because  it  seemed  necessary  as  a war  measure,  but  in 


25 


Railroads  From  the  Investor’s  Viewpoint 


so  doing  floundered  about  in  a sea  of  irresponsible  and 
inexperienced  centralized  direction  and  were  given  little  or 
no  assurance  of  financial  or  corporate  independence.  We  all 
know  that  under  this  system  the  difficulties  of  operation 
multiplied  to  an  extent  that  made  government  operation  not 
only  a military  necessity  for  the  country,  but  a financial 
necessity  for  the  roads.  It  is  said  that  private  operation 
under  military  necessity  could  hardly  have  been  continued 
without  at  least  financial  demoralization  of  the  roads  and 
perhaps  general  bankruptcy.  True,  it  was  recognized  that 
the  taking  over  of  the  railroads  of  the  country  by  the  Gov- 
ernment would  be  attended  with  certain  serious  evils.  It 
was  recognized  that  it  might  result  in  laxity  of  executive 
direction,  in  inefficiency  of  operation  on  the  part  of  labor, 
in  increased  costs  of  operation  with  decreasing  earnings,  as 
well  as  in  deterioration  of  equipment  and  road  bed.  All  of 
these  things  we  know  actually  did  result  from  government 
control,  and  yet  it  was  probably  the  only  course  which  could 
have  been  pursued  from  the  standpoint  of  the  good  of  the 
country  and  the  good  of  the  roads  as  a whole. 

Fadairal  ©p©ira{Ln©im 

The  roads  were  taken  over  by  the  government  on  Jan- 
uary 1,  1918.  They  were  rented  by  the  government  at  a 
rental  which  amounted  to  the  average  net  operating  earnings 
of  each  road  for  the  three  years  preceding  government  con- 
trol. The  year  1915  was  not  a very  good  year  for  the  roads ; 
1916,  on  the  other  hand,  was  one  of  the  best  years  they  had 
ever  had;  1917  was  an  average  year.  An  average  of  the  net 
earnings  of  all  three  years  was  considered  to  be  a very  fair 
allowance  for  the  roads  during  the  period  of  Government 
control.  A contract  to  this  effect  was  made  by  the  Govern- 
ment with  each  railroad  separately  and  individually.  There 
were  some  cases  where  this  general  arrangement  seemed  to 
be  unfair  to  the  roads,  as  in  the  case  of  the  Western  Pacific, 
which  had  just  gone  through  receivership  and  had  had  prac- 
tically no  net  earnings  during  the  three  years  previous  to 
government  control.  In  situations  like  this,  where  the 
railroad  objected  to  the  plan  of  Government  rental,  the  cases 
were  taken  up  by  a referee  and  decided  individually. 


26 


Federal  Securities  Corporation 


The  period  during  government  control  can  probably  be 
passed  over  very  quickly  because  the  results  of  such  opera- 
tion are  more  or  less  fresh  in  our  minds.  It  was  necessary 
for  the  government,  of  course,  to  have  absolute  control  of 
traffic,  to  give  preference  to  shipment  of  troops  and  of  war 
materials,  and  to  make  the  interest  of  shippers  secondary. 
Traffic  was  diverted  from  customary  channels — certain 
roads  were  asked  to  take  care  of  an  unusually  heavy  density 
of  traffic ; on  others  the  traffic  was  lighter  than  under 
ordinary  conditions.  This  could  not  but  result  in  ineffi- 
ciencies of  operation  by  reason  of  congestion  of  traffic  in 
certain  spots  and  thinness  in  certain  others.  One  unfor- 
tunate result  was  that  because  a road  had  no  responsibility, 
it  was  not  as  particular  as  formerly  in  getting  foreign  cars 
out  of  its  hands  and  back  to  the  owning  railroad. 

The  roads  were  under-equipped,  and  the  equipment 
under-maintained.  When  the  railroads  were  taken  over,  the 
the  freight  cars  and  other  equipment  generally  were  in  poor 
condition,  because  of  the  universal  labor  shortage.  Because 
of  the  car-pooling  arrangement  under  government  control, 
there  was  little  incentive  for  operating  officials  to  keep  their 
cars  in  repair  since  only  a small  percentage  of  each  com- 
pany’s cars  would  remain  on  its  own  line.  This  situation 
could  not  but  contribute  to  a general  freight-car  and 
passenger-car  deterioration,  especially  since,  under  pres- 
sure, cars  and  locomotives  were  often  kept  on  the  rails 
when  they  should  have  been  in  the  repair  shops.  More- 
over, during  the  twenty-six  months  of  government  control 
only  100,000  new  freight  cars  and  1900  new  locomotives 
were  ordered  and  put  into  use.  Prior  to  Federal  control 
the  average  production  of  freight  cars  each  twelve  months 
had  been  100,000  so  that  there  was  a greater  shortage  of 
car  equipment  at  the  end  of  Federal  control  than  at  the 
])eginning. 

Moreover,  all  costs,  as  everyone  no  doubt  remembers, 
including  labor  and  materials,  were  increased  tremendously 
during  the  period  of  the  war,  whereas  freight  rates  were 
increased  almost  not  at  all  until  the  war  was  practically 
over.  The  total  rental  which  it  was  necessary  for  the 


27 


Railroads  From  the  Investor’s  Viewpoint 


government  to  pay  in  each  year  amounted  to  about  $950,- 
000,000.  In  1919,  when  the  net  operating  income  of  the 
railroads  was  less  than  $550,000,000,  the  loss  to  the  govern- 
ment in  operating  the  roads  was  over  $400,000,000.  The 
final  result  according  to  the  report  of  Director  General 
Hines  made  to  President  Wilson  on  February  28th,  1920, 
was  that  this  was  an  excess  of  operating  expenses  and 
rentals  over  operating  revenue  for  26  months  amounting 
to  $715,500,000.  We  mention  this  merely  to  show  the 
tremendous  increases  in  labor  and  operating  costs  to  the 
railroad  companies  without  corresponding  increases  in 
rates. 

The  roads  were  in  government  hands  for  twenty-six 
months.  On  March  1,  1920,  at  the  time  they  were  turned 
back  to  private  ownership.  Director  General  Hines  of  the 
Railroad  Administration  issued  a statement  in  which  he 
briefly  analyzed  the  operation  under  government  control. 
He  said  he  knew  the  government  had  been  severely  criticized 
because  of  the  deficit  which  had  been  incurred,  but  he 
pointed  out  that  the  cost  of  transportation  had  to  be  paid 
in  one  way  or  another,  and  that  it  was  exactly  the  same 
whether  the  money  was  taken  out  of  the  people  in  the  form 
of  taxes  or  in  the  form  of  increased  freight  rates.  As  it  was, 
the  medium  of  taxation  was  chosen  because  of  the  unsettling 
effect  large  increases  in  freight  rates  would  have  had  on  bus- 
iness generally.  It  was  necessary  that  all  business  should 
go  forward  as  smoothly  as  possible  because  of  the  great 
need  for  manufactured  articles  of  all  kinds  during  and 
because  of  the  war.  It  did  not  seem  politic  to  increase 
freight  rates ; but  since  the  increased  costs  of  labor  and  of 
materials  increased  costs  of  operation  to  the  point  of  a 
deficit,  it  became  necessary  to  make  up  the  deficit  in  the 
form  of  taxes. 

In  justification  of  his  position.  Director  Hines  drew  an 
analogy  between  the  history  of  the  operation  of  the  railroads 
during  the  war  and  the  history  of  the  operation  of  the 
United  States  Steel  Corporation.  The  Steel  Company’s 
operating  costs  from  1914  to  1918  increased  150%,  whereas 
the  operating  costs  of  the  railroads  increased  102%.  The 


28 


Federal  Securities  Corporation 


cost  per  unit,  moreover,  of  the  Steel  Company’s  product 
increased  61%,  whereas  the  railroads’  cost  per  unit  of  traffic 
increased  60%. 

Mr.  Hines  further  pointed  out  that  certain  situations, 
over  which  he  had  no  control,  greatly  increased  the  cost  of 
transportation  for  the  government.  For  example,  the 
increase  in  rates  granted  in  June  of  1918  should  have  been 
granted  long  before  that  time.  If  it  had  been  granted  in 
January  instead,  the  net  advantage  to  the  roads  would  have 
been  about  $494,000,000.  Again,  we  all  remember  the  coal 
strike,  which  took  place  in  the  fall  of  1919,  the  results  of 
which  were  not  chargeable  to  the  Government,  but  which 
cost  the  Government  $114,000,000  net  in  operating  the  car- 
riers. Further  than  this,  the  deficit  of  about  $400,000,000, 
which  occurred  in  operating  the  railroads  in  1919,  was  in 
very  large  part  occasioned  by  the  extraordinary  slump  in 
freight  business  in  the  first  six  months  of  that  year.  Mr. 
Hines  estimated  the  deficit  in  these  six  months  at  $292,500,- 
000  as  against  a total  deficit  for  the  year  of  about  $400,000,- 
000.  The  deficit  during  the  first  six  months  is  not  properly 
chargeable  to  government  operation,  because  the  war  was 
over  and  the  slump  in  traffic  would  have  been  there  just  the 
same,  whether  the  roads  themselves  or  the  government  were 
operating  the  carriers. 

All  told,  while  the  operation  of  the  roads  by  the  govern- 
ment was  a costly  procedure,  it  would  seem  that  under  the 
circumstances  results  were  as  good  as  could  have  been 
expected.  Under  war  time  conditions,  it  was  necessary 
that  the  public  generally  should  pay  for  the  cost  of  forced 
transportation  under  trying  conditions,  and  the  method 
chosen  to  make  this  payment  was  probably  just  as  good 
as,  if  not  ])etter  than,  any  other  that  was  possible. 


It  is  very  interesting  to  study  the  results  of  the  various 
railroad  companies  during  the  twenty-six  months  of  govern- 
ment control,  because  it  is  a pertinent  indication  of  the 


29 


Railroads  From  the  Investor’s  Viewpoint 


strength  and  earning  capacity  of  the  various  properties.  A 
road  must  not  be  judged,  of  course,  on  this  shovcing  alone, 
because,  in  the  case  of  many,  influences  over  which  the 
managers  of  the  property  had  no  control  tended  toward  a 
poor  showing.  However,  those  roads  which  in  spite  of 
generally  increased  costs  and  in  spite  of  inadequate  in- 
creases in  freight  rates  were  able  to  earn  amounts  equal  to 
or  even  exceeding  the  amounts  of  the  government  rental, 
are  clearly  shown  to  be  strong  properties,  at  least  during 
the  period  of  government  control. 

The  fact  that  during  1918  and  1919  both  the  Atchison 
and  Union  Pacific  earned  amounts  greater  than  the  govern- 
ment rental  is  a most  interesting  commentary  on  the  finan- 
cial strength  of  these  two  systems.  The  Michigan  Central 
also  is  in  this  class,  as  well  as  the  Nickel  Plate,  the  Pere 
Marquette,  and  the  Big  Four.  The  Oregon  Short  Line, 
which  is  really  part  of  the  Union  Pacific,  also  in  both  years 
earned  more  than  its  guarantee.  The  Western  Pacific,  too, 
falls  into  this  class,  probably  only  because  it  had  just  passed 
through  a receivership  period  of  small  earnings. 

The  Delaware,  Lackawanna  & Western,  the  Chesapeake 
& Ohio,  the  Atlantic  Coast  Line,  the  Louisville  & Nashville, 
the  Southern,  the  St.  Louis  & San  Francisco,  and  the  St. 
Louis  Southwestern,  were  among  the  roads  which  earned 
more  than  their  guarantee  in  one  of  the  two  years.  The 
Southern  roads,  generally,  made  a very  good  showing,  be- 
cause of  the  fact  that  the  army  camps  were  located  in  the 
South  occasioning  large  increase  in  traffic  during  those 
years.  The  New  York  Central  earned  almost  its  guarantee 
during  both  years  but  made  a better  showing  in  1919  than 
in  1918.  The  Norfolk  & Western  also  made  a good  show- 
ing in  both  years.  The  Chicago,  Burlington  & Quincy,  the 
Southern  Pacific,  the  Northern  Pacific,  the  Rock  Island, 
the  Denver  & Rio  Grande,  as  well  as  the  Kansas  City 
Southern  and  Texas  & Pacific,  fall  into  this  same  group  of 
roads  which  made  a very  good  showing  but  fell  short  of 
earning  their  guarantee  during  two  years. 

On  the  other  hand,  certain  roads  which  one  would  ordin- 
arily expect  to  make  a better  showing,  did  rather  poorly. 


30 


Federal  Securities  Corporation 


The  Illinois  Central  earned  $12,900,000  in  1918,  and  only 
$4,000,000  in  1919,  as  compared  with  the  government  guar- 
antee of  $16,000,000.  The  Great  Northern  earned  about 
$12,000,000  in  both  years,  as  compared  with  the  government 
guarantee  of  over  $28,000,000.  The  Chicago  & Northwestern 
similarly  earned  about  $12,000,000  each  year  as  compared 
with  the  rental  of  over  $23,000,000.  The  Philadelphia  & 
Reading,  which  also  is  a strong  road  and  should  be  classed 
with  the  others  just  mentioned,  earned  $11,000,000  in  1918, 
and  only  $5,000,000  in  1919,  as  compared  with  a guarantee 
of  over  $17,000,000.  It  is  not  surprising,  of  course,  that  the 
New  England  Roads  did  not  do  very  well.  The  New  Haven 
with  a standard  return  of  about  $17,000,000  earned  $7,700,000 
in  1918  and  $6,900,000  in  1919.  The  Boston  & Maine  earned 
$1,895,000  in  1918  and  $3,577,000  in  1919  compared  with  a 
rental  of  $9,832,000.  The  Boston  and  Albany  earned  about 
half  its  guarantee,  and  the  Maine  Central  showed  a deficit 
in  both  years. 

The  Delaware  & Hudson  and  the  Lehigh  Valley,  both 
of  which  are  anthracite  roads  and  which  might  be  expected 
to  make  a good  showing,  did  relatively  quite  poorly.  The 
Central  of  New  Jersey,  also  an  anthracite  road  made  a fair 
showing  in  1918  with  net  earnings  of  $6,000,000  but  in  1919 
fell  off  with  earnings  of  only  $1,400,000  as  compared  with  a 
guarantee  of  over  $9,000,000.  The  Pennsylvania  Lines,  both 
East  and  West,  did  not  show  very  well  during  the  war. 
The  eastern  lines  were  guaranteed  $51,000,000  net,  whereas 
in  1918,  the  earnings  were  only  about  $19,900,000  and  in 
1919  a little  over  $8,000,000.  The  lines  west  of  Pittsburg 
showed  $4,400,000  net  in  1918,  and  $5,700,000  in  1919  com- 
pared with  a $14,000,000  guarantee.  It  is  not  surprising,  of 
course,  that  roads  like  the  Wabash,  the  Chicago  Great 
Western,  the  Seaboard  Air  Line  and  the  Missouri  Pacific 
should  not  do  as  well  as  some  of  the  other  roads,  but  the 
poor  showing  of  the  Chicago,  Milwaukee  & St.  Paul  is 
probably  the  greatest  surprise  of  all.  This  road  earned  only 
$3,900,000  in  1918,  and  $3,200,000  in  1919,  as  compared  with 
a gox'ernment  guarantee  of  almost  $27,900,000. 


31 


Railroads  From  the  Investor’s  Viewpoint 


Tla©  Train!§p®rftafta®im  Acit 

On  March  1,  1920,  as  we  have  previously  mentioned,  the 
roads  were  turned  back  to  their  original  owners.  Mr.  Wilson 
in  1919  had  promised  that  he  would  turn  the  roads  over  to 
their  owners  on  January  1,  1920.  He  frankly  said  that  he 
did  not  know  how  this  was  to  be  done,  but  he  hoped  that 
certain  legislation  would  be  put  through  by  Congress  so 
that  this  might  be  effected.  A railroad  bill  had  been  in 
preparation  in  the  House,  as  a matter  of  fact,  by  Mr.  John  J. 
Esch  of  Wisconsin  and  in  the  Senate  by  Mr.  Cummins  of 
Iowa. 

The  problem  resolved  itself  into  effecting  a compromise 
between  the  two  bills,  and  during  the  first  week  in  February 
the  conferees  came  to  an  agreement.  On  February  18,  the 
bill  was  completed  in  conference  and  the  legislation  pro- 
posed by  the  conferees  was  reported  to  the  Senate  and  to 
the  House,  passed  and  finally  signed  on  February  28,  1920. 

The  bill  as  it  is  now  in  operation  contains  the  following 
provisions : 

1.  Freight  and  passenger  rates  so  to  be  adjusted  by  the 
Interstate  Commerce  Commission  as  to  yield  the  carriers 
for  the  two-year  period  beginning  March  1,  1920,  a return 
of  5^4%  on  the  aggregate  value  of  railroad  property,  with 
permission  on  the  part  of  the  Interstate  Commerce  Com- 
mission to  make  this  allowed  return  6%,  the  additional  ^ of 
1%  to  be  used  for  non-productive  maintenance,  betterments 
and  equipment. 

2.  One  half  of  a railroad’s  net  operating  income  in 
excess  of  6%  of  its  property  value  to  be  distributed  equally 
between  the  road’s  reserve  fund  and  the  Federal  Railroad 
Contingent  Fund,  the  latter  to  be  administered  by  the  Com- 
mission for  the  assistance  of  weaker  roads. 

3.  The  government  to  continue  its  guarantee  of  stand- 
ard return  to  all  the  roads  for  six  months  after  the  date  of 
resumption  of  private  operation  up  to  September  1,  1920 — 
rates  and  fares  as  well  as  wages  not  to  be  reduced  prior  to 
that  date  without  the  consent  of  the  Interstate  Commerce 
Commission. 


32 


Federal  Securities  Corporation 

. 4.  Permission  to  be  granted  to  consolidate  the  railroads 
of  the  country  in  accordance  with  a general  consolidation 
plan  to  be  prepared  by  the  Interstate  Commerce  Com- 
mission. , 

5.  All  labor  disputes  to  be  submitted  to  a permanent 
Federal  Board  appointed  by  the  President,  to  be  composed 
of  nine  members,  three'-^representing  the  employees,  three 
representing  the  railroads,  and  three  representing  the  public. 

6.  $300,000,000  to  be  appropriated  as  a revolving  fund  for 
the  purpose  of  making  loans  to  the  railroads  and  of  paying 
claims  to  them  on  account  of  disputes  arising  out  of  Federal 
control,  the  railroads  to  pay  interest  on  the  money  so  loaned 
at  the  rate  of  6%.  (The  bill  originally  provided  that  this 
was  to  be  paid  back  in  five  years,  but  on  June  5,  1920,  by 
amiendment  the  time  was  extended  to  fifteen  years.) 

It  will  be  seen  that  by  the  provisions  of  this  bill  each 
road  was  guaranteed  for  six  months  a return  equal  to  that 
which  it  received  under  government  control.  After  Septem- 
ber 1,  1920,  the  bill  did  not  guarantee  any  return  whatso- 
ever. It  merely  authorized  the  Interstate  Commerce  Com- 
mission to  regulate  rates  and  fares  by  geographical  districts 
in  such  a way  as  to  yield  5)4%  on  the  aggregate  fair  value 
of  all  the  railroad  property  investment  in  each  district. 

The  Interstate  Commerce  Commission  has  divided  the 
country  into  four  districts — the  Eastern,  the  Southern,  the 
Mountain  Pacific,  and  the  Western  districts.  In  a general 
way  the  Eastern  district  includes  the  railroads  north  of  the 
Ohio  River  and  east  of  the  Mississippi  River;  the  Southern 
district  includes  those  roads  south  of  the  Ohio  River  and 
east  of  the  ^lississippi ; the  ATstern  district  is  the  area  west 
of  the  Mississip])i  and  east  of  an  irregular  line  drawn  through 
what  is  called  the  “Denverpoints” ; while  the  Mountain 
Pacific  district  includes  those  roads  west  of  the  Western 
district  to  the  Pacific  C(;ast.  Each  of  these  districts  con- 
tains weak  as  well  as  strong  roads,  but  the  bill  does 
not  mean  that  each  road,  strong  or  weak,  is  guaranteed 
5)4%  on  its  value,  as  determined  by  the  Commission.  It 
means  that  rates  should  be  S(j  adjusted  that  the  return  will 


33 


Railroads  From  the  Investor’s  Viewpoint 


be  5^%  on  the  aggregate  property  value  of  all  the  railroads 
in  each  district.  This  would  probably  mean  more  than 
5^%  for  the  strong  roads  and  less  than  that  for  the  weak. 

After  6%  has  been  earned  by  a railroad  upon  its  fair 
value,  without  regard  for  other  income,  the  excess  over  this 
amount  shall  be  divided  between  the  railroad  which  earned 
the  excess  and  the  Railroad  Contingent  Fund.  This  fund 
is  to  be  used  either  for  making  loans  to  the  carriers  or  for 
the  purchase  of  equipment  to  be  leased  to  the  carriers.  In 
either  case,  the  government  is  to  receive  from  the  railroad 
6%  on  the  amount  so  invested.  The  railroads’  share  of  the 
surplus  above  6%  of  the  property  value,  is  to  be  placed  in  a 
Trust  Fund  for  the  purpose  of  building  up  a surplus  for  the 
road  until  this  fund  equals  5%  of  the  property  value  of  any 
particular  carrier,  after  which  the  road  is  privileged  to  use 
it  for  any  purpose  it  desires.  This  fund  may  be  used  for 
making  up  interest  or  dividends  during  those  years  when 
the  carriers’  earnings  are  less  than  the  required  amount. 


Such  was  the  situation  when  on  March  1 the  railroads 
were  turned  over  to  their  private  owners.  Under  govern- 
ment ownership,  it  is  said  that  the  railroad  expenses  in- 
creased over  $1,500,000,000  a year.  Whatever  the  amount 
was,  the  roads  were  left  with  a real  legacy  of  enormously 
increased  expenses,  with  properties  that  were  in  poorer 
shape  than  when  they  were  turned  over,  and  with  less,  and 
in  many  cases  much  poorer,  equipment.  The  railroads  were 
faced  with  the  serious  problem  of  meeting  this  situation  of 
poor  condition  of  road  l)ed  and  equipment  with  expenses 
and  labor  costs  constantly  increasing. 

The  employees  during  the  first  six  months  of  private 
operation  were  negotiating  for  higher  wages.  On  April 
16,  the  first  meeting  of  the  Labor  Board  under  the  Trans- 
portation Act  was  called  and  on  July  20  this  Board  an- 
nounced at  Chicago  that  wage  increases  had  been  awarded, 
which  it  was  estimated  at  the  time  would  add  $600,000,000 
to  the  operating  expenses  of  the  roads.  \Vhile  these  nego- 
tiations were  going  on,  the  roads  themselves  were  nego- 


34 


Federal  Securities  Corporation 


tiating  for  increased  rates  and  on  May  24  hearings  were 
opened  by  the  Interstate  Commerce  Commission.  On  July 
29,  the  Interstate  Commerce  Commission  granted  the  rail- 
roads increases  in  freight  and  passenger  rates,  which  it  was 
then  estimated  would  yield  about  $1,500,000,000  additional 
revenue  per  year  to  the  carriers,  the  new  rates  to  become 
effective  on  August  26.  Under  the  decision  of  the  Commis- 
sion the  roads  in  the  Eastern  District  were  authorized  to 
increase  their  freight  rates  40%,  those  in  the  Southern  and 
Mountain  Pacific  Districts  25%,  and  those  in  the  Western 
District  35%.  The  Commission  also  authorized  the  carriers 
to  advance  passenger  rates  20%,  Pullman  rates  50%,  and 
excess  baggage  and  milk  rates  20%. 


The  report  of  the  Commission  at  the  time  these  rate 
increases  were  authorized  is  a very  interesting  document. 
The  problem  which  was  presented  to  them  was  to  fix  rates 
for  the  railroads  in  the  different  groups  at  such  a figure  that 
for  the  two  year  period  ending  March  1,  1922,  they  would 
yield  at  least  5^4%  on  the  fair  value  of  the  aggregate 
physical  property  of  the  roads  in  a given  district.  The  first 
thing  to  ascertain  and  establish,  therefore,  was  the  aggre- 
gate value  of  the  railway  property  of  the  carriers  held  for 
and  used  in  the  service  of  transportation.  The  valuation 
work  of  the  railroads  under  the  Interstate  Commerce  Com- 
mission Act  was  still  incomplete,  but  the  work  had  pro- 
gressed so  far  that  the  results  were  of  great  value  in  reach- 
ing the  determination  which  the  Commission  needed  as  a 
basis.  From  the  valuations  which  had  been  made  and  other 
evidence  which  was  submitted,  as  well  as  information 
which  the  Commission  had  obtained,  the  Commission  deter- 
mined that  the  total  value  of  the  steam  railway  property 
for  their  purpose  was  approximately  $18,900,000,000, 
divided  as  follows: 

Eastern  Group  $ 8,800,000,000 

Southern  Group  2,000,000,000 

Western  and  Mountain  Pacific  Group..  8,100,000,000 

$18,900,000,000 


35 


Railroads  From  the  Investor’s  Viewpoint 

The  carriers  themselves  asked  for  rates  which,  capital- 
ized on  the  basis  of  a 6%  return,  would  make  the  value  of 
the  properties  in  excess  of  $20,500,000,000  and  they  actually 
carried  the  cost  of  road  and  equipment  on  their  books  at  a 
figure  in  excess  of  $20,000,000,000. 

The  Eastern  carriers  asked  that  they  be  permitted  to 
earn  an  annual  net  railway  operating  income  of  $559,409,933 
which  would  represent  6%  on  the  book  cost  of  $9,323,498,- 
898.  The  figures  for  1919  showed  that  the  rates  in  effect  at 
the  time  the  investigation  was  going  on  would  fall  short 
$500,000,000  annually  of  earning  the  net  railway  operating 
income  to  which  they  claimed  they  were  entitled.  The 
Commission  recognized  that  not  only  had  there  been  a 
sharp  decline  in  railway  operating  income  during  the 
previous  three  or  four  years,  but  also  that  the  operating 
ratio  had  increased  at  “a  rate  that  causes  serious  concern.” 
For  the  five  years  prior  to  1916  the  operating  ratio  of  the 
Eastern  carriers  was  71%.  This  had  increased  to  75%  in 
1917,  to  almost  86%  in  1918,  to  88^%  in  1919  and  97.68% 
in  the  first  four  months  of  1920.  This  means  that  during 
the  first  four  months  of  1920,  after  paying  operating 
expenses  there  was  left  only  2.32  cents  out  of  each  dollar 
for  the  payment  of  interest  on  funded  debt,  taxes  and  other 
items  such  as  rents,  hire  of  equipment,  leases,  etc. ; in  short 
for  the  payment  of  fixed  charges.  During  the  six  year 
period  beginning  with  1912,  it  took  approximately  28.79 
cents  out  of  every  dollar  of  operating  revenue  to  pay  these 
fixed  charges,  so  that  the  need  of  the  Eastern  carriers  for 
an  increase  in  rates  was  immediately  apparent.  In  addition 
to  the  above,  it  will  be  recalled  that  in  July,  1920,  the  Labor 
Board  placed  in  effect  a general  increase  in  wages  which 
it  was  estimated  would  add  approximately  $314,500,000 
annually  to  the  operating  expenses  of  the  carriers  in  the 
Eastern  group.  This  entire  situation  in  the  opinion  of  the 
Commission  could  be  met  by  a 40%  increase  in  freight 
rates  and  by  the  other  increases  previously  rehearsed. 

In  the  Southern  group,  as  a whole,  the  situation  was 
much  more  favorable.  The  carriers  in  this  group  asked 
that  their  rates  be  increased  so  that  they  might  earn  net 


36 


Federal  Securities  Corporation 

$136,049,091  which  represents  a return  of  6%  on  a value  of 
$2,267,484,847.  The  roads  in  the  Southern  group  estimated 
that  under  the  schedule  of  rates  in  effect  at  the  beginning 
of  1920,  their  operating  income  would  be  approximately 
$120,000,000  less  than  this  sum.  The  operating  expenses 
in  this  group  had  like  those  in  the  Eastern  district  in- 
creased heavily  but  not  to  the  same  extent.  During  the 
six  years  ended  1917,  the  operating  ratio  of  the  Southern 
carriers  varied  from  65%  in  1916  to  74%  in  1914.  In  1918 
it  was  77%%,  in  1919  it  had  advanced  to  86%,  and  for  the 
first  four  months  of  1920  was  86.22%.  The  roads  in  this 
group  asked  for  an  increase  of  approximately  31%  in  freight 
revenue  and  received  an  advance  of  25%  in  freight  together 
with  the  general  advance  in  passenger  and  Pullman  rates 
previously  outlined. 

In  the  Western  and  Mountain  Pacific  groups  the 
carriers  requested  that  their  rates  be  fixed  on  a basis  to 
permit  them  to  earn  $537,833,024  which  represents  a 6% 
return  on  $8,963,883,753.  On  the  basis  of  the  prediction  of 
the  carriers  the  operating  income  of  these  districts  would 
fall  short  approximately  $350,000,000  of  the  amount  to 
which  they  believed  they  were  entitled.  The  operating 
ratio  of  the  roads  in  these  groups  had  increased  similarly 
with  those  in  the  other  two  groups.  This  ratio,  which 
between  1912  and  1917  had  ranged  from  63%  to  68%,  had 
advanced  to  81%  in  1919  and  to  86.6%  for  the  first  four 
months  of  1920.  In  taking  the  various  figures  of  the  roads 
in  this  group  and  adjusting  them  to  the  standard  set  by 
the  Interstate  Commerce  Commission,  it  was  determined 
that  the  return  stipulated  under  the  Esch-Cummings  Bill 
could  be  earned  through  an  increase  for  the  Western  group 
of  35%  in  freight  rates  and  for  the  Mountain  Pacific  group 
of  25%,  together  with  the  general  increases  in  passenger 
and  other  rates. 

In  the  opinion  of  the  Interstate  Commerce  Commission 
these  increases  in  rates,  both  freight  and  passenger,  would 
yield  at  least  5%%  on  the  total  valuation  of  the  railroads 
of  the  country  as  determined  by  them.  In  this  connection 
it  is  very  interesting  to  note  that  the  aggregate  valuation 


37 


Railroads  From  the  Investor’s  Viewpoint 


the  Commission  placed  on  the  properties  not  only  covers 
all  of  the  funded  debt  of  the  railroads  at  par,  but  also  covers 
all  the  capital  stock  of  the  railroads  at  par  and  leaves  a 
margin  of  about  $2,000,000,000  besides.  In  other  words, 
in  the  opinion  of  the  Commission,  the  roads  are  today  con- 
servatively worth  $2,000,000,000  more  than  their  entire 
capitalization. 


IResMlits  Uimdleir  Private  ©peratiem 

The  law  says  the  roads  are  entitled  to  earn  5^%  to  6% 
on  this  valuation  or  between  $1,039,500,000  and  $1,134,000,- 
000.  There  seems  to  be  a misconception,  not  so  much  on 
the  part  of  the  investing  public,  but  rather  on  the  part  of 
the  general  public,  about  the  Transportation  Act.  It  seems 
popularly  to  be  supposed  that  under  the  terms  of  the  Act 
the  government  guarantees  5^2%  to  6%  on  the  railroad 
investment.  The  Transportation  Act  says  that  rates  shall 
be  so  arranged  as  to  allow  the  roads  to  earn  a net  profit 
of  between  5^%  and  6%  on  the  aggregate  property  value 
but  the  government  does  not  guarantee  this  profit.  The 
Interstate  Commerce  Commission  itself  can  only  guess  as 
to  whether  the  rates  it  fixes  will  produce  the  adequate 
profit.  It  can  only  control  rates;  it  cannot  control  volume 
of  traffic,  nor  price  of  material,  of  money  or  of  labor.  As 
a matter  of  fact  it  has  no  assurances  as  to  labor  costs  as 
wages  are  fixed  by  the  Federal  Labor  Board  without  con- 
sultation with  the  Interstate  Commerce  Commission. 

Much,  of  course,  depends  on  the  efficiency  of  the  rail- 
roads themselves  and  we  all  know  that  the  efficiency  of  the 
railroads  was  greatly  increased  during  the  first  year  of 
private  operation.  When  the  roads  were  turned  back  to 
their  original  owners,  most  of  the  operators  began  im- 
mediately to  improve  and  rehabilitate  their  properties,  as 
well  as  to  increase  efficiency  all  along  the  line.  The 
carriers  during  the  first  year  of  operation  for  their  own 
account,  spent  millions  of  dollars  on  road-beds  and 
terminals. 

We  have  previously  mentioned  how  equipment  was 
neglected  during  the  period  of  the  war  and  how  new  equip- 


38 


Federal  Securities  Corporation 


ment  necessary  to  the  efficient  operation  of  the  roads  was 
not  added  when  needed.  The  fact  that  $125,000,000  of  the 
$300,000,000  revolving  fund  authorized  by  the  Transporta- 
tion Act  was  allotted  for  the  purchase  of  equipment  shows 
the  need  of  the  roads  in  this  respect.  Many  of  the  carriers 
in  1921  purchased  new  equipment  financed  through  equip- 
ment trust  obligations  sold  to  the  public  and  most  of  them 
showed  increased  efficiency  in  the  use  of  the  old  equipment 
available. 

As  a matter  of  fact,  the  first  six  months  of  private  opera- 
tion, during  which  the  government  guarantee  was  in  force, 
were  dedicated  to  increasing  the  efficiency  of  the  roads. 
To  show  what  was  accomplished : the  tonnage  per  freight 
car  was  increased  from  28.3  tons  on  March  1,  1920,  to  29.8 
tons  on  September  1.  This  does  not  seem  a large  gain  but 
put  in  terms  of  freight  cars  it  means  the  equivalent  of 
adding  100,000  freight  cars  to  the  equipment  of  the  systems. 
The  average  mileage  per  day  was  also  increased  from  22.3 
on  March  1,  1920,  to  27.4  on  September  1,  1920,  a gain 
which  is  equivalent  to  400,000  freight  cars.  The  number 
of  cars  loaded  also  showed  a great  increase  and  the  number 
of  tons  moved  one  mile  during  the  first  six  months  of  1920, 
were  3,000,000,000  tons  more  than  during  the  first  ten 
months  of  1918,  which  was  a record  year  in  the  midst  of 
the  war.  During  the  year  after  the  termination  of  Federal 
control  the  roads  moved  9,000,000,000  ton  miles  more  than 
in  1918  employing  the  same  facilities.  These  latter  figures 
did  not  continue  in  force  during  1921  when  traffic  slumped 
but  they  are  illustrative  of  the  genuine  effort  the  roads 
made  toward  efficiency  and  the  splendid  results  accom- 
plished. 

Tn  spite  of  these  efficiencies  and  economies  the  rail- 
roads did  not  earn  anywhere  near  their  5j/%  to  6%  return 
for  1920  nor  did  they  do  so  in  1921.  Tn  1920  the  net  income 
of  the  railroads  was  only  $62,000,000;  had  the  government 
not  guaranteed  the  standard  return  up  to  September  1 
there  would  have  been  a deficit  in  railroad  operation  of 
roundly  $2,000,000,000.  As  it  was  the  $62,000,000  net  was 
asked  to  pay  interest  charges  of  about  $450,000,000.  Hy 


39 


‘Railroads  From  the  Investor's  Viewpoint 


comparison  we  may  mention  that  in  1916  the  roads  earned 
net  $1,040,000,000  which  was  $240,000,000  more  than  div- 
idend requirements.  During  the  first  five  months  of  opera- 
tion under  the  new  rates,  that  is,  September,  1920,  to 
January,  1921,  inclusive,  with  a volume  of  business  that 
was  considered  large  enough  to  produce  the  standard 
5)4%,  the  roads  as  a whole  earned  only  3%. 

For  the  first  six  months  of  1921  the  net  revenue 
amounted  to  $142,000,000.  This  was  about  one  quarter  of 
what  the  law  entitled  the  roads  to  earn  and  was  $95,000,000 
short  of  enough  to  pay  six  months’  interest  on  the  bonds 
of  the  companies.  From  September  1,  1920,  when  the 
guaranty  period  ended  to  June  30,  1921,  the  roads  earned 
net,  $368,445,000  or  at  the  rate  of  about  2.5%.  For  eight 
months  of  1921,  ended  xVugust  31,  the  roads  failed  to  earn 
the  authorized  6%  by  over  $692,000,000  and  again  earned 
only  2.6%  on  the  aggregate  valuation.  The  figures  show 
that  during  the  first  twelve  months  of  operation  under 
private  ownership,  that  is  up  to  September  1,  1921,  the 
roads  earned  a smaller  return  on  the  book  cost  of  their 
road  and  equipment  than  in  any  year  since  railway  statis- 
tics were  kept.  The  amount  earned  in  this  twelve  months 
was  less  than  3%  of  the  aggregate  value.  The  smallest 
return  in  any  previous  year  of  which  there  is  a record  is 
1894  when  3.2%  was  earned.  How^ever,  earnings  improved 
from  month  to  month  and  during  August,  1921  the  roads 
for  the  first  time  earned  at  the  rate  of  5)4%  on  the  aggre- 
gate value,  the  net  earnings  in  this  month  being  over 
$90,000,000. 


Resiioiriis  for  Cunrfiaikd  EarnEinigs 

\\  by,  then,  if  the  roads  increased  their  efficiencies  so 
greatly  did  they  failed  to  earn  their  stipulated  return  in 
the  face  of  the  very  generous  increases  in  rates  granted 
in  xAugust,  1920?  The  reasons  were  three:  (1)  There  was 
a great  slump  in  business  in  1921  and  consequently  in  the 
volume  of  traffic  handled  by  the  roads.  (2)  The  rates  of 
increase,  while  generous,  were  still  not  large  enough  to 


40 


Federal  Securities  Corporation 


produce  the  required  revenue.  (3)  The  operating  costs  of 
the  roads  had  been  tremendously  increased. 

The  slump  in  business  we  have  all  felt  and  remember. 
In  the  early  part  of  1921  the  slump  was  at  its  height,  but 
as  the  year  went  along  traffic  seemed  to  pick  up  and  earn- 
ings  grew  better.  Earnings  are  an  indication  of  this : in 
February  there  was  an  actual  deficit  of  $7,000,000  in  opera- 
tion while  in  September  the  roads  reported  net  earnings  of 
over  $90,000,000.  To  illustrate;  in  July  traffic  had  already 
begun  to  quicken  materially  as  indicated  in  the  results  in 
terms  of  net  earnings  but  even  so  the  number  of  cars 
loaded  in  four  weeks  in  July  was  2,981,106  as  compared 
with  3,559,081  during  the  same  weeks  of  1920  and  3,365,049 
for  the  same  weeks  of  1919. 

An  analysis  of  the  car  loadings  is  interesting  as  indicat- 
ing which  particular  kinds  of  traffic  showed  the  greatest 
falling  off.  It  is  a peculiar  fact  that  the  shipments  of 
agricultural  products,  of  grain,  and  of  merchandise,  espe- 
cially the  higher  grades  of  manufactured  products  were 
very  large  and  in  some  instances  greater  in  1921  than  in 
1920  or  1919.  On  the  other  hand,  shipments  of  bulkier 
materials  were  unprecedentedly  small ; namely,  coal,  iron 
ore,  forest  products,  lime,  cement,  etc.  When  we  consider 
what  a large  part  of  the  traffic  of  the  roads  is  always  made 
up  of  the  bulky  products  of  mines  and  forests,  it  is  easy  to 
understand  the  great  falling  off  of  traffic  in  the  first  half 
of  1921.  Coal,  itself,  ordinarily  constitutes  35%  of  the 
total  tonnage  of  the  roads. 

The  coal  situation  was  unprecedented.  From  Decem- 
ber, 1920,  when  the  coal  shipment  situation  was  about 
normal,  to  May  1921,  in  the  short  space  of  five  months,  the 
tonnage  of  coal  shipped  per  day  was  almost  cut  in  tvvo.  In 
fact  never  have  the  coal  shipments  been  relatively  as  small 
as  they  were  in  the  first  ])art  of  1921.  The  years  1914  and 
1915  like  1921,  were  years  of  business  depression.  Since 
then  the  population  of  the  country  has  increased  and  the 
needs  of  manufacture  have  greatly  increased.  And  yet  in 
tlie  first  seven  months  of  1921  the  shipments  of  bituminous 
coal  were  12,000,000  tons  less  than  in  1914  and  2,000,000 


41 


Railroads  From  the  Investor's  Viewpoint 


less  than  in  1915.  In  a comparison  with  1919,  we  hnd  a 
falling  off  of  29,000,000  tons  and  with  1918,  of  110,000,000 
tons  for  the  seven  month  period  from  January  to  July. 

We  have  said  that  one  reason  for  the  failure  of  the 
roads  to  earn  their  5j4%  was  that  the  increases  in  rates, 
while  generous,  were  not  large  enough ; nor  were  they 
properly  timed.  Since  1915,  there  have  been  four  general 
increases  in  rates:  3.7%  in  January,  1917;  2%  in  March, 
1918;  25%  in  June,  1919;  and  an  average  of  34%  in  August, 
1920.  The  total  increase  was  78%.  Operating  expenses 
in  the  same  period  increased  from  $2,055,181,884  for  the 
fiscal  year  ended  June  30,  1915  to  $5,830,696,007  for  the 
calendar  year  1920.  Even  considering  the  expenses  for  the 
calendar  year  1915  as  $2,250,000,000  which  would  be  very 
generous,  the  increase  in  operating  expenses  was  over 
150%  in  the  six  year  period  as  compared  with  a 78%  in- 
crease in  freight  rates.  The  increase,  of  course,  was  all 
that  business  would  stand  but  the  point  is  that  it  was  not 
enough  to  permit  the  roads  to  earn  534%  on  their  book 
values.  The  railroads  also  point  out  that  if  the  rates  had 
been  gradually  advanced  from  time  to  time  since  1915,  the 
shock  to  business  would  not  have  been  so  great  and  the 
returns  to  the  roads  larger  and  steadier. 


Iinicireas©  m ©poiraftninig 

lAw  people  seem  to  realize  how  tremendously  the 
operating  costs  of  the  railroads  have  increased  in  recent 
years.  A few  general  statements  will  emphasize  the 
startling  truth.  We  have  said  that  the  operating  costs 
increased  over  150%  from  1915  to  1920.  In  1918,  the 
operating  expenses  were  greater  than  the  total  operating 
revenue  for  1917,  with  about  the  same  volume  of  traffic. 
The  labor  cost  in  1920  was  greater  than  the  entire  gross 
operating  revenue  in  1916,  again  with  about  the  same 
volume  of  traffic.  The  labor  cost  itself  had  advanced  from 
$1,190,000,000  in  1915  to  $3,698,000,000  in  1920,  or  much 
more  than  trebled.  Material  costs  advanced  from  $447,- 
000,000  in  1915  to  $1,064,000,000  in  1920.  Material  costs 
have  been  usually  from  34  to  34  as  great  as  labor  costs,  yet 


42 


Federal  Securities  Corporation 


the  material  costs  of  1920  were  almost  identical  with  the 
labor  costs  of  1915.  It  is  rather  startling  that  in  1920  the 
net  earnings  left  after  operating  expenses  were  only  1% 
out  of  total  operating  revenues  of  $6,171,000,000  as 
against  28.9%  in  1916  from  gross  operating  revenues  of 
$3,596,000,000. 


The  labor  cost  is  the  one  over  which  the  most  dis- 
cussion and  conflict  has  occurred.  There  has  been  in  the 
past  and  probably  will  continue  to  be,  a wide  divergence 
of  opinion  as  to  how  the  labor  question  should  be  adjusted. 
The  transportation  act  provides  that  Boards  of  Labor  Ad- 
justment might  be  local  to  a railroad,  might  be  regional,  or 
might  be  national  in  jurisdiction.  Managers  of  the  roads 
have  always  felt  that  they  themselves  should  deal  with 
their  own  employees  by  means  of  local  boards.  The  rail- 
road men  on  their  part  insist  that  the  boards  be  national, 
and  that  the  power  be  centralized.  The  roads  naturally 
have  fought  wage  increases  in  view  of  mounting  costs 
while  the  employees  have  resented  decreases. 

The  labor  problem  of  the  roads  can  best  be  illustrated 
by  showing  what  percentage  of  each  dollar  earned  during 
various  years  was  paid  out  for  the  most  important  items  of 
expense  and  what  percentage  was  left  the  roads  as  return 
on  the  investment,  thus : 

1916  1917  1918  1919  1920 


% % % % % 

Labor  40.8  43.3  53.6  55.3  59.9 

Fuel  7.0  9.8  10.2  9.2  10.9 

Materials  12.5  12.2  13.1  15.6  17.3 


Return  on  Investment...  28.9  23.3  13.1  8.8  1.0 

The  minor  items  are  omitted  in  the  above  table  which 
shows  that  in  1920  about  60%  of  the  total  gross  revenue 
of  the  roads  was  paid  in  wages  as  against  41%  in  1916. 
The  following  figures  show  the  yearly  average  wage  of  rail- 
road employees : 

1916  1917  1918  1919  1920 

$892  $1,004  $1,419  $1,482  $1,908 

43 


Railroads  From  the  Investor’s  Viewpoint 


The  wage  per  man  has  more  than  doubled.  Moreover, 
in  1917  the  last  year  the  roads  were  operated  privately  dur- 
ing the  war  the  average  number  of  employees  was  1,732,- 
876.  In  1920  wdien  the  roads  were  turned  back  the  average 
number  of  employees  was  1,993,524,  a gain  of  260,000  em- 
ployees during  the  period  of  government  control.  The 
roads  contend  that  this  increase  in  the  number  of  men  was 
occasioned  by  the  national  agreements  with  their  very 
costly  labor  arrangements.  These  special  arrangements 
which  the  managers  were  forced  to  accept  when  the  roads 
were  turned  back  to  private  operation  are  said  to  have 
added  $300,000,000  to  the  annual  operating  costs  of  the 
properties. 

The  best  way  to  visualize  the  gradual  decrease  in  net 
income  and  the  increase  in  labor  costs  is  to  show  the  figures : 

Gross  Revenue  Labor  Cost  Net  Income  Return 


1916  $3,597,000,000  $1,468,000,000  $1,040,000,000  6.16% 

1917  4,014,000,000  1,739,000,000  934,000,000  5.26% 

1918  4,881,000,000  2,613,000,000  639,000,000  3.51% 

1919  5,145,000,000  2,843,000,000  455,000,000  2.46% 

1920  6,171,000,000  3,698,000,000  62,000,000  .32% 


This  shows  that  the  labor  cost  for  1920  was  greater  than 
the  total  gross  revenue  for  1916.  The  1919  labor  cost  was 
just  about  equal  to  the  1917  total  operating  expense.  Again 
the  1918  total  operating  expense  was  less  than  $400,000,000 
more  than  the  1920  labor  cost. 

The  wage  increase  put  in  effect  in  July,  1920,  was  an 
average  increase  of  22%  in  wages.  It  was  estimated  it 
would  add  $600,000,000  to  the  expenses  of  the  roads.  The 
wage  decrease  put  into  effect  on  July  1,  1921,  was  an 
average  decrease  of  12%.  It  was  estimated  to  reduce 
operating  expenses  $400,000,000  while  the  abrogation  of 
the  national  agreements  was  estimated  to  reduce  the 
amount  another  $300,000,000  when  effective.  The  em- 
ployees resented  the  cut  in  wages  and  when  further  reduc- 
tions were  asked  for  by  the  roads  with  a disposition  on 
the  part  of  the  Federal  Labor  Board  to  grant  them  the 
employees  in  October,  1921,  threatened  a nation-wide  strike 
Avhich  was  averted  only  by  Federal  interference. 


44 


Federal  Securities  Corporation 


The  employees,  however,  recognize  that  a cut  in  wages 
was  not  only  inevitable  but  imperative.  The  managers  on 
their  part  recognize  that  a reduction  in  freight  rates  was 
also  essential.  In  fact,  at  the  time  of  the  threatened  strike  a 
bulletin  of  the  Association  of  Railway  Executives  stated, 
‘Tt  is  evident  that  existing  transportation  charges  bear  in 
many  cases  a disproportionate  relationship  to  the  prices  at 
Avhich  commodities  can  be  sold  in  the  market,  and  that 
existing  labor  and  other  costs  of  transportation  thus  impose 
upon  industry  and  agriculture  generally  a burden  greater 
than  they  should  bear.  This  is  especially  true  of  agriculture. 
The  railroad  managements  are  sensitive  to  and  sympathetic 
with  the  distressing  situation  and  desire  to  do  everything 
to  assist  in  relieving  it  that  is  compatible  with  their  duty  to 
furnish  the  transportation  which  the  public  must  have.” 

In  November,  1921,  the  Interstate  Commerce  Commis- 
sion proposed  and  the  roads  accepted  a ten  per  cent  de- 
crease in  the  rates  on  agricultural  products,  efiective  about 
January  1,  1922.  Other  decreases  must  follow  as  decreases 
in  Avages,  materials  and  money  occur.  It  should  be  borne 
in  mind  that  a fifteen  per  cent  reduction  in  operating 
expenses  based  on  1920  figures  means  $875,000,000  annually 
to  the  roads;  a twenty  per  cent  reduction  means  $1,160,- 
000,000  or  the  equivalent  of  six  per  cent  in  the  total  aggre- 
gate value  of  the  properties.  This  does  not  seem  so  hope- 
less as  some  were  pleased  to  think  during  the  early  part 
of  1921.  In  fact,  it  is  not  hopeless  at  all ; it  is  A^ery  probable 
indeed. 

m C©inidEftn®inis 

The  situation  grew  stronger  month  by  month  almost 
continuously  during  1921.  The  government  on  its  part 
strengthened  and  clarified  its  position  greatly  during  the 
year  by  the  sale  of  a considerable  portion  of  the  equipment 
trust  obligations  it  owned  as  well  as  by  settling  a large 
number  of  the  claims  of  the  carriers  against  the  govern- 
ment as  a result  of  Federal  operation.  Up  to  October 
])ractical]y  v$100, 000,000  of  the  6%  equipment  trust  obliga- 
tions OAvned  by  the  government  had  been  sold  to  financial 


45 


Railroads  From  the  Investor’s  Viewpoint 


houses  who  had  in  turn  resold  them  to  the  public.  The 
government  originally  had  about  $380,000,000  of  these 
equipment  trust  obligations  and  it  is  only  a question  of 
time  when  the  balance  will  be  marketed.  With  respect  to 
settlement  of  carrier’s  claims,  as  much  progress  had  been 
made.  Up  to  October  1st  sundry  claims  aggregating  $856,- 
000,000,  growing  out  of  Federal  operation,  had  been  filed 
for  final  settlement.  These  claims  represented  about  78% 
of  the  total  mileage  under  government  control  and,  there- 
fore, the  total  amount  of  claims  was  expected  to  reach  some- 
thing over  $1,000,000,000.  Up  to  October  1st,  1921,  claims 
aggregating  $387,000,000,  or  almost  half  of  the  amount  filed 
up  to  that  time,  had  been  finally  adjusted  and  paid.  The 
amount  of  the  government  allowances  on  these  claims  was 
$117,715,000,  or  about  30%  of  the  amount  claimed. 

The  progress  of  the  roads  themselves  has  been  very 
evident  in  the  reports  of  the  net  earnings  from  month  to 
month.  It  will  be  recalled  that  during  January  and 
February  of  1921,  the  roads  earned  a deficit  in  each  month. 
From  March  to  August,  inclusive,  the  operating  results 
have  been  as  follows : 


Operating  Operating 

Revenue  Expenses  Net  Income 

March  $459,262,510  $400,429,308  $30,695,192 

April  433,357,199  375,698,986  29,248,874 

May  444,875,089  380,041,234  37,080,654 

June  461,562,317  380,927,429  51,641,014 

July  462,849,446  362,841,183  69,298,521 

August  505,508,274  382,279,070  90,241,103 


Three  tendencies  are  at  once  apparent  from  an  examina- 
tion of  these  figures:  (1)  the  tendency  of  the  gross 
revenues  to  increase  from  month  to  month  showing  a slight 
increase  in  volume  of  traffic,  (2)  the  tendency  of  the 
operating  expenses  to  decrease  (at  least  in  percentage  of 
gross)  indicating  either  increased  efficiency  or  decreased 
maintenance,  or  both,  and  (3)  the  tendency  of  the  net  in- 
come to  increase  showing  a tendency  to  approach  the  level 
where  5j4%  to  6%  of  the  property  values  will  be  earned. 
In  August,  1921,  the  $90,000,000  of  net  earnings  was  at  the 
annual  rate  of  a little  over  5l4%  on  the  property  value  of 


46 


Federal  Securities  Corporation 


$18,900,000,000  allowed  by  the  Commission.  In  September, 
the  net  had  fallen  off  slightly  to  about  $87,000,000,  but  still 
at  the  rate  of  5^%. 


As  indicated  in  the  above  figures,  the  increase  in  net 
earnings  from  month  to  month  has  been  due  to  two  causes : 
(1)  increased  efficiency  in  operation  and  decreased  main- 
tenance, and  (2)  increased  business  from  month  to  month. 
The  decline  in  material  prices  has  also  had  its  influence, 
and  the  wage  reduction  has  been  a big  factor  in  the  months 
since  July. 

In  the  matter  of  maintenance,  the  roads  report  that  they 
spent  $373,000,000  less  for  maintenance  for  the  first  eight 
months  of  1921  than  they  did  in  the  same  period  of  1920. 
Had  the  maintenance  been  the  same  for  1921  as  for  1920, 
instead  of  realizing  a net  operating  income  of  over  $303,- 
000,000  for  eight  months  there  would  have  been  an  actual 
deficit  of  over  $70,000,000.  During  September  of  1921,  the 
gross  operating  revenues  were  19.6%  less  than  during 
September,  1920,  while  operating  expenses  were  26% 
smaller.  Expenditures  on  maintenance  for  September, 
1921,  showed  a decrease  of  23.3%,  but  slightly  larger  than 
in  August.  This  reduction  represents  a postponement  of 
outlay  until  conditions  improve  rather  than  an  actual 
saving. 

It  has  been  only  by  the  most  rigid  economies  that  the 
roads  were  able  to  make  the  showings  registered.  That 
the  roads  had  a better  hold  on  their  expenditures,  is  in- 
dicated in  the  fact  that  in  June,  1921,  82.34  cents  out  of 
every  dollar  of  revenue  went  for  expenses  compared  with 
85.43  cents  in  May.  In  June,  1920,  the  figure  was  96.84 
cents  and  in  May,  1920,  95.69  cents.  In  July,  1921,  the 
operating  ratio  had  fallen  to  78%  and  in  August,  1921  to 
about  75%.  We  have  already  detailed  earlier  how  during 
1920  the  roads  had  increased  the  average  movement  per 
car  per  day,  as  well  as  the  average  tonnage  per  car,  and 
the  average  number  of  cars  ])er  train,  lly  buying  on  a 
hand  to  mouth  basis,  es])ecially  coal,  and  by  intensive 


47 


Railroads  From  the  Investor’s  Viewpoint 

efforts  to  reduce  coal  and  material  consumption,  as  well  as 
by  cutting  the  number  of  employees  down  to  the  very 
minimum,  considerable  additional  savings  in  operation  were 
effected.  In  reaching  the  low  ratios  of  operation  for 
August  and  September,  1921,  not  only  were  the  economies 
of  operation  and  the  retrenchment  in  maintenance  opera- 
tive, but  the  reduction  in  wages  and  the  increase  in  traffic 
had  their  contributing  influence. 

Traffic  was  on  the  upturn  from  month  to  month  during 
1921,  as  reflected  in  the  figures  of  gross  revenues  and  in 
the  car  loading  reports.  The  tendency  during  the  entire 
year  1921  has  been  toward  an  increase  in  the  volume  of 
traffic  in  grain  and  general  merchandise,  but  against  an 
increase  in  the  movement  of  the  heavier  products  of  mines, 
such  as  coal  and  ore,  the  backbone  of  freight  traffic.  From 
month  to  month  the  freight  car  loadings  have  shown  in- 
creases and  the  idle  car  figures  decreases.  A few  figures 
chosen  at  random  will  be  of  interest.  For  the  week  ending 
July  30th,  1921,  the  freight  loadings  totaled  796,570  cars, 
an  increase  of  6,222  cars  over  the  previous  week.  Again 
the  week  of  August  30th,  1921,  showed  a gain  of  7,471  cars 
over  the  previous  week.  The  total  for  the  week  of  August 
30th  was  816,436  cars,  a gain  of  about  20,000  cars  in  a 
month.  In  one  week  of  September,  1921,  the  loadings  were 
830,603  cars  while  in  the  corresponding  week  of  October, 
the  number  of  car  loadings  had  increased  to  901,078,  or  an 
approach  to  1920  levels.  In  one  month  from  August,  1921 
to  September,  1921,  the  idle  cars  decreased  from  513,040  to 
237,972,  a reduction  of  over  50%. 

Pireseinift  SiftimsiftEOini  mmd  Funftiuiira  Pir©M®imis 

The  situation  is  improving  and  will  gradually  straigliten 
itself  out.  Problems  of  moment  are  still  ahead  of  the 
roads,  the  administration,  the  Labor  Board  and  the  Inter- 
state Commerce  Commission,  but  every  day  progress  is 
being  made  toward  settlement  of  a situation  that  in  tlm 
early  part  of  1921  seemed  exceedingly  difficult  of  solution. 
The  future  must  solve  other  problems.  In  IMarch,  1922, 
for  example,  the  first  two  year  period  of  operation  under 


48 


Federal  Securities  Corporation 


private  control  will  have  ended,  and  it  will  be  up  to  Con- 
gress and  the  Interstate  Commerce  Commission  to  make 
new  regulations  or  to  continue  in  effect  the  ones  now  opera- 
tive. But  this  should  not  concern  us.  The  solution  of  the 
railroad  difficulty  always  has  been  and  always  will  be 
found.  The  roads  are  too  vital  a part  of  our  life  and 
prosperity  for  any  other  result  ever  to  come  about.  Posi- 
tive influences  are  daily  working  in  this  direction.  Before 
Congress  at  this  time,  for  example,  is  the  Funding  Plan 
which  is  strongly  being  urged  by  President  Harding  as  a 
contributing  force  to  the  solution  of  the  railroad  problems. 
The  Interstate  Commerce  Commission  in  accordance  with 
the  provision  of  the  Transportation  Act  is  studying  the. 
possibility  of  consolidations  among  the  roads  and  has  in- 
vited reports  of  experts  on  this  very  important  question. 
Consolidation  of  the  weaker  systems  with  the  stronger  can- 
not help  but  fortify  the  whole  fabric. 

However  complex  the  situation  may  be  at  this  time,  it 
would  seem  to  us  that  the  railroad  companies  are  today  in 
a much  stronger  position  than  they  have  been  probably 
at  any  time  in  their  history.  They  are  operating  under  a 
law  which  should  in  time  assure  the  average  road  annually 
5^%  net  on  its  property  valuation.  The  general  situation 
in  the  industry  is  strengthened  because  the  basic  principles 
on  which  the  roads  are  working  are  more  firmly  estab- 
lished. The  trying  conditions  of  today  and  tomorrow  are 
transient  and  will  pass,  but  the  basic  principles  of  operation 
of  the  roads  will  remain  to  control  continued  prosperity 
over  a long  period  of  time. 

However,  while  this  is  true  and  while  the  railroads  as 
a whole  are  in  a stronger  situation  fundamentally  than 
they  have  been  in  the  past,  the  comparative  relationships 
between  the  different  properties  will  probably  continue  as 
before.  What  we  mean  to  say  is  that  just  as  in  the  past 
there  have  been  strong  roads,  average  roads  and  weak 
roads,  so  in  the  future  the  various  systems  will  fall  in  much 
the  same  classifications.  The  earning  power  and  prosperity 
of  any  individual  road  will  in  the  future  depend  on  mucli 
the  same  factors  as  heretofore,  namely  conservatism  in 


49 


-Railroads  From  the  Investor’s  Viewpoint 


capitalization,  degree  of  up-keep  of  property,  and  efficiency 
of  operation.  The  past  history  of  railroading  will  have  its 
influence  on  the  future  of  the  entire  industry.  It  is  for  this 
reason  that  the  past  history  of  the  railroads  of  the  country 
should  be  of  value  to  the  investor  in  his  consideration  of 
railroad  bonds. 


50 


Federal  Securities  Corporation 


lEI 

IRAILROAD  SECURITIES 

The  average  investor  is  probably  much  better  acquainted 
with  the  factors  to  be  considered  in  judging  railroad  securi- 
ties than  he  ‘is  with  the  past  or  even  more  recent  history 
of  the  railroads  of  the  United  States.  It  is  for  this  reason 
that  we  have  outlined  as  fully  as  the  booklet  would  permit, 
the  history  of  the  railroads  and  will  condense  as  much  as 
clearness  and  accuracy  will  permit,  the  detail  of  those 
factors  essential  of  consideration  in  the  purchase  of  rail- 
road bonds. 


Tike  Tw®  Impoffftamft  Factors 

Whether  the  investment  be  railroad,  municipal,  utility 
or  industrial  bond,  there  are  two  fundamentals  which 
govern  its  worth:  (1)  The  lien  position  of  the  bond  itself 
and  (2)  the  credit  position  of  the  issuing  corporation. 
There  is  a third  consideration  which  often  influences  inves- 
tors’ minds  as  to  the  worth  of  a bond,  namely,  market- 
ability— but  it  is  obvious  that  marketability  has  no  bearing 
on  security  and  it  is  security  that  we  wish  solely  to  take 
into  account. 

So  far  in  this  booklet  in  Parts  I and  II  we  have  dealt 
only  with  the  second  of  these  two  large  considerations,  the 
credit  position  of  the  roads.  We  have  outlined  the  credit 
position  of  the  railroads  of  the  country  as  a whole  especially 
during  the  past  few  chaotic  years  and  we  have  indicated 
here  and  there  the  credit  positions  of  various  individual 
roads.  We  have  given  sufficient  outline  of  the  various  ups 
and  downs  of  the  railroad  systems  of  the  country  to  need 
no  further  emphasis  on  the  point  that  the  credit  of  a road 
is  of  great  importance.  We  have  seen  sound  roads  like 
the  New  England  systems  gradually  grow  into  a situation 
of  great  financial  weakness.  We  have  also  seen  other 
roads,  like  the  Atchison  and  the  Northern  Pacific  change 
from  a position  of  financial  weakness  to  one  of  consider- 
able financial  strength.  Again  we  know  that  certain  prop- 


51 


Railroads  From  the  Investor’s  Viewpoint 


erties  like  the  Pennsylvania,  the  New  York  Central,  the 
Louisville  and  Nashville  and  Illinois  Central  started  with 
the  ideal  of  conservative  capitalization  and  strong  financial 
position,  continue  through  the  decades  to  maintain  this 
strong  financial  structure  and  credit. 

Although  a record  of  the  past  is  generally  conceded  to 
be  a fair  guarantee  of  the  future,  we  must  remember  that 
there  are  notable  instances  when  a record  of  the  past 
proved  a sad  guarantee  of  the  future.  This  point  must  be 
kept  in  mind  in  considering  the  records  which  we  have  just 
reviewed. 

So  far  we  have  emphasized  the  importance  of  the 
credit  position  of  the  railroads  in  judging  their  investments. 
But  the  factor  of  credit  position  should  not  be  over  em- 
phasized at  the  expense  of  the  other  consideration,  namely, 
the  lien  position  of  the  bond.  Both  should  be  considered 
jointly  in  order  to  determine  what  is  a sound  investment. 
Sometimes  investors  are  prone  to  emphasize  one  of  these 
factors  at  the  expense  of  the  other.  The  lien  position  of  one 
of  the  railroads  now  in  a weak  credit  position  may  in  itself 
be  exceedingly  strong  but  it  is  not  a very  comfortable  feel- 
ing to  realize  that  the  credit  of  the  system  may  jeopardize 
the  payment  of  principal  and  interest,  in  spite  of  the 
inherent  strength  of  the  investment. 

On  the  other  hand,  too  much  emphasis  should  not  be 
placed  on  the  mortgage  position  of  a certain  bond.  This 
fact  was  most  convincingly  brought  out  in  the  reorganiza- 
tion a few  years  ago  of  the  Missouri  Pacific  system.  Hold- 
ers of  first  mortgage  bonds  issued  at  a low  rate  per  mile  on 
branch  lines  which  were  not  very  valuable  in  earning  power 
to  the  system  were  in  the  reorganization  given  less 
desirable  securities  in  exchange  for  their  holdings  than  the 
holders  of  junior  securities  on  main  line  mileage.  It  did 
them  little  good  to  complain  because  it  mattered  very  little 
to  the  general  good  of  the  system  whether  these  lines  were 
included  or  divorced  in  reorganization ; they  contributed 
practically  nothing  to  the  credit  position  of  the  road. 

Then,  too,  the  credit  position  of  a road  may  be  so  empha- 
sized that  the  lien  position  of  a security  is  forgotten,  as,  for 


52 


Federal  Securities  Corporation^ 


example,  in  the  case  of  the  Southern  Pacific  Company  Con- 
vertible 4’s  which  are  merely  unsecured  obligations  of  a 
holding  company.  When,  however,  good  security  as  deter- 
mined by  lien  position,  is  coupled  with  good  credit,  the 
investor  has  a very  high  type  of  investment  security. 

The  two  factors  which  we  are  now  considering  are  in 
many  ways  bound  to  one  another.  It  follows  that  the 
bonds  of  a road  conservatively  capitalized  enjoy  a better 
lien  position  than  those  of  a road  which  is  over  capitalized. 
It  also  follows  that  a road  which  has  a low  bonded  debt 
per  mile  is  in  a better  earning  power  position  than  one 
which  has  a large  bonded  indebtedness,  traffic  possibili- 
ties in  the  two  territories  being  equal.  Investors  who 
study  railroad  investments  carefully  and  especially  those 
who  may  be  acquainted  with  Mr.  Moody's  Analysis  of 
Railroad  Investments  instinctively  combine  these  two  con- 
siderations in  analyzing  a railroad  investment  that  may  be 
offered.  There  are  many  considerations  which  may  be 
taken  into  account  in  analyzing  a railroad  security  but  the 
bondman  and  the  well  posted  investor  simmer  these  down 
to  one : namely,  a comparison  of  the  bonded  debt  of  the 
road  per  mile  with  the  earning  power  of  the  road  per  mile. 
This  one  consideration  combines  the  two  factors  of  lien 
position  and  credit  position,  as  will  at  once  be  evident.  The 
lien  position  is  indicated  by  the  bonded  debt  per  mile.  The 
credit  position  is  indicated  by  the  net  earnings  per  mile. 

To  illustrate  what  we  mean  we  will  use  certain  figures 
taken  from  the  last  current  volume  of  Moody’s  Analysis 
of  Railroad  Investments.  To  take  a very  extreme  case  we 
will  compare  the  indebtedness  and  the  earning  power  of 
the  Atchison  with  the  indebtedness  and  earning  power  of 
the  Erie.  In  1919  the  per  mile  bonded  debt  of  the  Atchison 
was  slightly  less  than  $25,000  and  in  1917  (the  last  figures 
given  by  Mr.  Moody),  the  net  earnings  per  mile  were 
$5,342.  The  Erie,  on  the  other  hand,  showed  bonded  in- 
debtedness per  mile  in  excess  of  $126,000  and  net  earnings 
per  mile  for  1917  of  v$5,439.  Even  though  the  Erie  may 
have  more  second  and  third  track  mileage  than  the  Atchison 
it  is  at  once  apparent  that  most  of  the  securities  of  a road 


53 


Railroads  From  the  Investor’s  Viewpoint 


with  a bonded  indebtedness  of  $126,000  per  mile  have  a less 
desirable  lien  position  than  the  securities  of  a road  with  a 
bonded  indebtedness  of  $25,000  per  mile.  It  is  also 
apparent  that  a road  faced  with  the  necessity  of  paying 
interest  on  securities  outstanding  at  the  rate  of  $126,000 
per  mile  enjoys  a less  desirable  credit  position  than  one 
which  must  pay  interest  on  securities  at  the  rate  of  $25,000 
per  mile,  the  net  earnings  per  mile  of  each  system  being 
about  the  same. 

These  are  extreme  cases  chosen  deliberately  to  illustrate 
our  point.  Most  of  the  roads  will  fall  somewhere  between 
these  two  extremes  as  the  Atchison  is  one  of  the  most  con- 
servatively capitalized  of  roads  enjoying  the  highest 
measure  of  credit,  whereas  the  Erie  has  earned  much  the 
opposite  reputation.  All  the  other  roads  in  the  country 
fall  in  their  own  respective  niches  in  a comparison  of  this 
kind  and  the  investor  who  wishes  to  determine  these  facts 
can  obtain  them  from  the  good  investment  houses.  It 
would  be  interesting  to  compare  all  of  the  important  roads 
of  the  country  in  a test  of  this  character  but  the  scope  of 
this  booklet  will  not  permit.  We  believe  we  can  say,  how- 
ever, that  it  should  not  be  difficult  for  the  investor  to  con- 
clude for  himself  from  the  information  which  has  been 
given  in  this  booklet  which  are  the  roads  whose  lien  posi- 
tion and  credit  position  rank  high  and  those  whose  positions 
are  less  desirable. 

Classes  ©IF  IRanlif©a(dl  Boiadls 

A brief  discussion  of  the  different  types  of  railroad 
bonds  and  the  general  esteem  in  which  each  type  is  held 
should  be  of  interest  to  the  investor.  We  feel  that  the 
investor  is  more  or  less  familiar  with  these  classes  of  rail- 
road bonds  and,  therefore,  our  discussion  will  be  brief. 
First  we  will  consider  those  bonds  which  are  secured  by 
mortgage  on  the  mileage  of  the  railroad  system.  These 
naturally  fall  into  four  groups : 

1.  Divisional  Liens. 

2.  First  Mortgage  General  System  Liens. 

3.  General  or  Refunding  ^Mortgages. 

4.  Collateral  Mortgages. 


54 


Federal  Securities  Corporation' 


Divisional  Liens — The  Divisional  Liens  came  into  being 
through  the  growth  of  great  systems  and  by  consolida- 
tion of  small  properties.  A line  of  several  hundred 
miles  originally  operated  as  a separate  unit  and  having 
outstanding  against  it  first  mortgage  bonds  would  in  con- 
solidation become  a part  of  a larger  system.  The  first 
mortgage  bonds  of  this  original  line  thereby  become 
divisional  liens  of  the  larger  system.  The  Chicago  & North- 
western, for  example,  is  made  up  of  many  small  roads  which 
have  gradually  been  absorbed  into  the  parent  system.  The 
New  York  Central  is  an  end  to  end  consolidation  of  a great 
many  small  properties.  Practically  every  large  system  in 
the  country  has  its  divisional  liens. 

As  a general  rule  such  issues  are  of  high  character,  espe- 
cially in  roads  of  good  credit  and  the  bonds  sell  at  the  top 
prices.  However,  it  must  be  borne  in  mind  that  just  be- 
cause a bond  is  a divisional  lien  it  is  not  necessarily  strong 
because  first  mortgage  divisional  issues  may  fare  badly  with 
a road  of  weak  credit  as  in  the  instance  of  the  Missouri 
Pacific  reorganization.  However,  when  a divisional  lien 
covers  an  important  part  of  the  mileage  the  investment  is 
usually  conservative.  An  example  of  a very  strong  divi- 
sional lien  is  the  C.  B.  & Q.,  Illinois  Division  4%  bonds 
which  cover  practically  the  entire  mileage  of  the  Burlington 
system  in  Illinois  and  the  line  running  from  Chicago  to  the 
Twin  Cities.  The  Great  Northern  has  a number  of  issues 
of  divisional  bonds  issued  at  various  times  as  Mr.  Hill 
expanded  the  Great  Northern  system,  all  of  which  are  very 
high-grade  but  which  are  very  rarely  seen  in  the  market 
because  they  have  been  put  away  in  places  from  which  they 
do  not  come  out.  These  are  only  a few  of  a great  number 
of  very  fine  divisional  issues. 

First  Mortgage  General  System  Liens — The  second 
class  of  mortgage  bonds  are  those  which  are  secured  by  a 
first  mortgage  on  much  of  the  main  line  mileage  of  the 
large  systems  and  are  generally  considered  very  high  grade 
investments.  The  Northern  Pacific  Prior  Lien  4s,  the  Union 
Pacific  First  and  the  Land  Grant  4s,  the  C.  B.  & Q.  General 
4s  and  the  Atchison  General  4s  are  outstanding  examples 


55 


Railroads  From  the  Investor’s  Viewpoint 


of  this  type  of  investment.  The  last  two  issues  mentioned 
are  called  general  mortgage  bonds  and  while  they  are  not 
secured  by  first  mortgage  on  all  of  the  property  which  they 
cover  they  are,  nevertheless,  a first  mortgage  on  a consider- 
able portion  of  the  main  line  mileage.  Such  issues  are 
usually  better  known  and  enjoy  a wider  general  market 
than  the  divisional  liens  because  the  amounts  outstanding 
are  larger  and  give  a greater  trading  opportunity. 

General  Mortgages — As  the  roads  grew  and  new  need 
for  money  arose,  it  became  necessary  for  the  systems 
to  do  financing  by  means  of  junior  bond  issues  since 
most  of  the  mileage  was  already  covered  by  first  mort- 
gages. It  is  in  this  manner  that  refunding  mortgages  or 
the  first  and  refunding  mortgages  of  the  railroads  came 
into  being.  In  the  80s  and  90s  when  this  type  of  financing 
was  first  brought  out  on  a scale,  the  mortgages  were  called 
general  mortgages  rather  than  refunding  mortgages.  In 
most  cases  these  general  mortgages  cover  at  least  a part 
of  the  mileage  by  first  mortgage  and  sufficient  bonds  are 
reserved  to  retire  the  underlying  liens  as  they  become  due. 
Usually  such  issues  were  made  to  run  over  a period  of  100 
years  and  covered  the  entire  property  of  the  road  as  con- 
stituted at  the  time  of  issue,  including  the  terminals  and 
equipment.  Sometimes  when  such  issues  were  brought  out 
a considerable  portion  of  the  mileage  was  not  mortgaged 
as  in  the  case  of  the  C.  B.  & Q.  and  the  Atchison  mentioned 
above,  so  that  these  general  mortgage  bonds  covered  sev- 
eral thousand  miles  of  road  as  a first  mortgage.  The  inves- 
tor is  acquainted  with  the  general  mortgage  bonds  of  the 
Northwestern,  the  Northern  Pacific,  the  Pennsylvania  and 
other  roads  which  have  outstanding  this  class  of  security. 

Refunding  Mortgages — In  recent  years  these  general 
mortgage  bonds  have  not  been  used  largely  because 
they  were  limited  under  the  terms  of  the  indentures  to 
interest  not  to  exceed  4%  and  only  to  refund  underlying 
liens.  Instead  the  systems  have  used  the  refunding  mort- 
gage bonds  to  finance  their  requirements.  These  refunding 
mortgages  were  so  drawn  as  to  carry  a higher  coupon  rate 
than  4%  and  were  authorized  in  amounts  in  excess  of  the 


56 


Federal  Securities  Corporation 


underlying  lien  requirements,  thus  affording  the  roads  the 
opportunity  of  obtaining  additional  working  capital.  In 
cases  where  a road  has  outstanding  both  a general  mortgage 
and  a refunding  mortgage,  the  general  mortgage  has  usually 
been  closed  and  the  refunding  mortgage  covers  the  same 
property  and  anything  additional  which  the  road  may  have 
acquired  since  the  general  mortgage  was  issued.  There- 
fore, most  of  the  refunding  mortgages  are  secured  by  first 
mortgage  on  a small  amount  of  mileage  and  by  a second 
and  third  and  in  some  cases  by  a fourth  mortgage  on  the 
main  portion  of  the  road.  There  are  some  systems  in  which 
this  character  of  lien  has  been  given  the  name  of  refunding 
and  improvement  mortgage  as  in  the  case  of  the  New  York 
Central. 

Most  of  the  large  systems  have  outstanding  refunding 
liens  of  one  character  or  another.  In  the  case  of  roads 
of  high  credit  these  bonds  are  well  regarded.  For  example, 
the  refunding  4^s  of  the  Northern  Pacific  which  is  a road 
of  high  credit,  have  always  sold  at  higher  prices  than  the 
refunding  bonds  of  the  B.  & O.  which  has  not  at  all  times 
in  its  history  enjoyed  the  highest  standard  of  credit. 

Collateral  Mortgages — The  collateral  mortgages  can  be 
dealt  with  rather  briefly.  In  the  true  sense  of  the  word 
collateral  mortgages  secured  by  the  deposit  of  other 
securities  are  not  a direct  mortgage  on  line,  although 
l)onds  may  be  deposited  under  them  which  are  secured 
by  direct  mortgage.  In  other  cases  collateral  issues  may 
be  secured  by  deposit  of  stocks  and  other  junior  securities. 
The  Southern  Pacific  Company  Collateral  Trust  4s  of 
1949,  for  example,  are  secured  by  the  deposit  of  certain 
amounts  of  the  stock  of  the  Central  Pacific  Railway  Com- 
pany. The  Illinois  Central  has  outstanding  two  issues 
of  collateral  trust  4%  bonds  due  in  1952  and  in  1953,  each 
of  which  is  secured  by  a first  lien  on  important  mileage 
through  the  deposit  of  all  of  the  liens  outstanding  on  this 
mileage.  These  bonds  were  made  collateral  trust  issues  of 
the  Illinois  Central  because  the  credit  of  the  Illinois  Central 
was  higher  than  that  of  the  unknown  individual  lines  whose 
bonds  were  outstanding.  This  is  usually  the  reason  for  the 


Railroads  From  the  Investor’s  Viewpoint 


issuance  of  collateral  trust  bonds.  This  issuance  of 
collateral  trust  issues  can  be  carried  to  excess,  as  was  done 
in  the  case  of  the  Erie,  and  for  this  reason  collateral  issues 
should  be  carefully  scrutinized,  especially  since  the  tend- 
ency of  the  investor  in  considering  issues  of  this  kind  is  to 
emphasize  the  credit  position  of  the  road  at  the  expense  of 
the  lien  position  of  the  bonds. 

Many  roads  have  outstanding  several  other  classes  of 
securities,  namely,  debenture,  convertible,  income,  terminal, 
and  equipment  bonds. 

Debenture  Bonds — Debenture  issues  may  or  may  not  be 
secured  by  mortgage.  Usually  at  the  time  the  debenture 
bond  is  issued  it  is  not  secured  by  mortgage  but  merely  is 
the  obligation  of  the  company  to  pay.  Debenture  inden- 
tures, however,  often  carry  the  provision  that  if  any  further 
securities  are  put  out  on  the  property  the  debentures  in 
their  turn  are  equally  to  be  secured  with  the  new  bonds. 
The  New  York  Central  Debenture  4s  of  1934,  which  are  a 
well  known  bond  and  the  debenture  4s  of  1932  are  both 
equally  secured  with  the  New  York  Central  Consolidated  4s 
of  1998  which  are  a second,  third,  fourth  and  fifth  lien  on 
parts  of  the  New  York  Central  property.  The  Lake  Shore 
and  Michigan  Southern  Debenture  4s  of  1928  and  1931  simi- 
larly are  equally  secured  with  the  Lake  Shore  & Michigan 
Southern  3^s.  On  the  other  hand,  the  Convertible  Deben- 
ture 6s  due  in  1935,  are  not  secured  by  mortgage.  Again  in 
the  case  of  issues  of  this  character  the  investor  would  do 
well  to  scrutinize  carefully  the  lien  position  of  the  bond 
as  well  as  to  consider  the  credit  position  of  the  road. 

Convertible  Bonds — In  recent  years  convertible  bonds 
have  flourished.  In  some  instances  convertible  issues 
have  been  put  out  without  any  mortgage  security,  as  in  the 
case  of  the  Southern  Pacific  Company  Convertible  4s  of 
1929  and  the  Union  Pacific  Convertible  4s  of  1927  which, 
however,  are  no  longer  convertible.  In  more  recent  years 
the  convertible  bonds  have  been  equally  secured  with  the 
refunding  or  with  the  refunding  and  improvement  bonds 
which  immediately  antidated  the  issuance  of  the  convertible 
bonds.  Lor  example,  the  B.  & O.  Convertible  4l4s  are 


58 


Federal  Securities  Corporation 


equally  secured  with  the  refunding  and  general  5s  and  6s 
due  in  1995  and  the  Chicago,  Milwaukee  & St.  Paul  Con- 
vertible 5s  of  2014  are  equally  secured  with  the  general  and 
refunding  4^s  of  the  same  date.  This  road  also  has  out- 
standing some  convertible  4^s  due  in  1932  which  are 
equally  secured  with  both  the  convertible  5s  and  the  gen- 
eral and  refunding  bonds.  It  may  be  of  interest  that  the 
Debenture  4s  of  1934  and  the  Gold  4s  of  1925  are  equally 
secured  with  both  the  General  and  Refunding  4}^s  and  the 
two  convertible  issues  which  we  have  mentioned.  This  is  a 
field  which  is  very  complicated  and  where  the  most  care- 
ful character  of  scrutiny  should  be  paid  to  issues  in  con- 
sidering them  as  investments.  They  should  be  judged,  as 
in  previous  cases,  by  the  lien  position  of  the  bond  and  the 
credit  position  of  the  road  in  conjunction,  without  the  over 
emphasizing  of  either  one  of  the  two  factors. 

Income  Bonds — We  have  previously  mentioned  that 
in  receivership  and  reorganization,  the  important  thing 
has  always  been  to  reduce  the  fixed  charges  of  the  road 
within  the  limit  of  the  road’s  net  earnings.  One  of  the  ways 
of  accomplishing  this  purpose  is  to  permit  the  outstanding- 
par  value  amount  of  securities  to  remain  unchanged,  but  to 
make  the  interest  on  part  of  the  bonds  payable  only  if 
earned.  It  is  in  this  manner  that  Income  Bonds,  or  Adjust- 
ment Income  Bonds,  as  they  are  sometimes  called,  came 
into  being. 

In  the  Atchison  reorganization  of  1895  this  procedure 
was  followed,  with  the  result  that  we  have  outstanding 
today  the  Atchison  Adjustment  4’s,  which  while  secured 
by  mortgage  on  the  property,  are  payable  as  to  interest 
only  if  that  interest  is  earned.  Up  to  July  1st,  1900,  this 
interest  was  not  even  cumulative,  but  since  that  time  it  has 
been  cumulative  and  is  paid  out  of  surplus.  The  Seaboard 
Air  Line,  too,  as  a result  of  its  recent  reorganization  has 
had  outstanding  since  1909  an  issue  of  $25,000,000  Adjust- 
ment 5’s,  the  interest  on  which  is  payable  only  if  earned. 
The  interest  on  these  bonds  has  ])een  cumulative  from  the 
beginning.  The  St.  Louis  & San  Francisco  Railway  Com- 


59 


Railroads  From  the  Investor’s  Viewpoint 


pany  has  outstanding  two  issues  of  this  character  as  a result 
of  its  reorganization:  the  Cumulative  Adjustment  6’s, 
which  are  payable  as  to  interest  from  available  net  income, 
but  which  are  cumulative ; and  the  Income  Mortgage  6’s, 
due  in  1960,  which  are  payable  out  of  the  available  net  in- 
come of  the  company  for  each  fiscal  year  ending  June  30th, 
after  payment  of  interest  on  the  Cumulative  Adjustment 
6’s.  The  interest  on  these  latter  bonds  is  not  cumulative. 
In  each  of  these  cases,  the  bonds  are  a mortgage  on  prop- 
erty securing  the  payment  of  the  principal,  but  as  the  inter- 
est is  payable  only  if  earned,  the  worth  of  such  issues  is 
largely  dependent  upon  the  credit  position  of  the  road.  As 
a general  case.  Income  Bonds  are  not  highly  regarded, 
although  the  Adjustment  4’s  of  the  Atchison  rank  almost  on 
the  same  plane  with  other  high-grade  4%  railroad  bonds  of 
roads  of  the  best  credit.  The  reason  for  this,  of  course,  is 
the  excellent  credit  which  the  Atchison  has  enjoyed  almost 
continuously  since  its  reorganization  in  1895. 

Terminal  Bonds — From  the  standpoint  of  security  po- 
sition and  credit  position  it  is  difficult  to  find  a higher 
grade  investment  than  a Terminal  Bond  issued  against 
properties  located  in  the  larger  cities.  These  bonds  are 
safeguarded  in  several  ways.  First,  they  are  usually  a 
mortgage  on  terminal  properties,  either  passenger  or  freight 
or  both,  which  are  very  valuable  because  they  are  usually 
located  in  the  business  center  of  the  city.  Second,  the 
interest  on  these  bonds  is  usually  made  an  operating-  charge 
against  the  roads  which  use  the  terminal.  Third,  the  bonds 
are  very  often  guaranteed  in  addition  as  to  both  principal 
and  interest  by  the  user  railroads.  There  have  been  a 
number  of  instances  where  roads  which  have  been  in  re- 
ceivership and  have  been  in  default  on  even  first  mortgage 
bonds  on  their  systems  have  continued  to  pay  interest  on 
the  Terminal  Bonds.  The  reason  for  this  is  that  in  order 
to  continue  to  operate,  the  roads  must  continue  to  use  the 
terminals,  and  in  order  to  get  into  the  terminals  it  is  neces- 
sary to  pay  the  terminal  charges  which  cover  the  interest 
on  the  bonds.  The  terminal  charge  is  generally  regarded 


60 


Federal  Securities  Corporation 


as  an  operating  charge  and  is  considered  to  come  ahead  of 
all  bond  interest  on  the  other  securities  of  the  railroad. 

The  Chicago  Union  Station  6^’s,  which  are  guaranteed 
by  the  Chicago,  Burlington  & Quincy,  the  Pennsylvania, 
and  the  Chicago,  Milwaukee  & St.  Paul,  and  are  an  operat- 
ing charge  against  these  three  roads  and  the  Chicago  & 
Alton,  are  possibly  one  of  the  best  chosen  investments  of 
this  group.  The  terminal  companies  operating  in  Kansas 
City,  St.  Louis,  and  St.  Paul  have  also  outstanding  Terminal 
Bonds  which  are  very  highly  regarded ; and  in  a general 
way,  the  Terminal  Bonds  of  companies  in  the  larger  centers 
of  population  offer  opportunity  for  conservative  investment 
which  it  is  impossible  to  excel. 

Equipment  Bonds — Equipment  Bonds  generally  enjoy 
a reputation  much  like  that  of  Terminal  issues.  A road 
cannot  operate  without  its  equipment,  and  when  issued 
by  good  roads.  Equipment  Bonds  in  the  past  have  always 
been  considered  one  of  the  very  highest  forms  of  railroad 
investment.  Again,  as  in  the  case  of  Terminal  issues,  roads 
which  have  been  in  receivership  and  in  default  on  mortgage 
bonds  have  continued  to  pay  interest  and  principal  on  their 
Equipment  issues  when  due. 

It  is  the  usual  procedure  at  the  present  time  to  issue 
these  Equipment  Bonds  under  the  Philadelphia  Plan. 
Under  this  Plan,  the  title  to  the  equipment  does  not  remain 
in  the  railroad  company  itself,  but  a trust  is  created  and 
the  title  to  the  equipment  remains  with  the  trustee  until 
the  final  installment  of  the  notes  is  paid.  In  this  case, 
instead  of  being  a direct  obligation,  the  notes  or  certificates 
are  guaranteed  by  the  railroad  which  rents  the  equipment 
from  the  trustee,  the  rentals  being  sufficient  to  take  care 
of  interest  and  maturities  when  due.  The  investor  on  his 
part  does  not  receive  the  note  of  the  railroad  company  itself, 
1)Ut  the  certificate  of  the  trustee,  secured  by  the  equipment 
whose  title  rests  in  the  trustee.  The  general  record  of 
lUjuipment  Bonds  has  been  unusually  good,  and  when 
issued  by  roads  of  good  credit,  such  certificates  must  be 
considered  as  being  extremely  high  grade  investments. 


61 


Railroads  From  the  Investor’s  Viewpoint 


INVESTMENT  SAFETY 


62 


Federal  Securities  Corporation 


C0MCLUSI0M 

This  booklet  makes  no  attempt  to  treat  with  justice  any 
phase  of  the  railroad  situation.  The  history  of  operation  of 
the  railroads  from  the  time  of  our  entry  into  the  war  up 
to  the  present  time  has  been  treated  with  most  detail,  but 
by  no  means  exhaustively.  The  primary  idea  of  this  book- 
let is  to  give  the  investor  a bird’s  eye  view  of  the  past 
history  of  the  roads,  the  problems  which  they  have  faced 
in  the  past  few  years  and  are  facing  today,  and  the  factors 
to  be  considered  in  judging  railroad  investments. 

Many  questions  which  the  investor  will  ask  are  answered 
in  these  pages.  It  is  our  hope  that  the  most  important  ones 
have  been  covered.  Many  questions  unanswered  will  occur 
to  the  investor  who  reads  this  booklet  thoughtfully  and 
with  care.  To  such  the  Federal  Securities  Corporation 
extends  its  fullest  service.  If  there  are  analyses  of  partic- 
ular bonds  or  of  individual  railroad  systems  which  the 
investor  would  like,  we  will  be  glad  to  supply  the  informa- 
tion on  request.  Our  desire  in  publishing  this  booklet  is 
the  same  as  that  in  every  department  of  our  business,  to 
serve  the  investor  to  the  utmost  of  our  ability. 


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